Behind the latest price war breakout between Coles and Woolworths are much deeper forces than just another price skirmish between the food giants.
And these forces go to the heart of the way retail in Australia will change. This morning I attended a retail breakfast organised by Ferrier Hodgson and saw just how the profound changes that are looming will transform the retail space. And these changes will extend to all retail sectors, including small and large property owners.
About 18 months ago, when the Coles supermarket earnings before interest and tax margin was below 4 per cent and Woolworths' was just above 7 per cent, Coles made it clear that it believed that 7 per cent was unsustainable and that Woolworths had used its enormous lead over Coles in supply chain management, technology, store layouts and other retail practices to lift margins to levels that were among the highest in the world.
Coles was grateful Woolworths had not used that advantage to slash prices because Coles’ costs were then so high it would not have competed. Since then Coles has been investing feverishly to catch up to Woolworths and, while the gap has narrowed substantially, Coles is probably still only 50 per cent to 60 per cent of the way.
The current price war has taken place because Australian consumers are still not spending but will buy if there are attractive prices (this applies across the retail spectrum). Coles wants to lift demand via lower prices and is passing on some of the advantages of its most recent investments. Coles’ EBIT margin is now approaching 5 per cent while Woolworths' is now closer to 8 per cent. But Coles believes that there is a limit to the productivity improvements Woolworths can now achieve and at some point Coles will conclude its EBIT margin should peak. There will then be a price war which will cause Woolworths to lower its margins.
Against that background the Ferrier Hodgson breakfast was fascinating. Here are some of the points raised:
- The high Australian food and non-food margins have attracted overseas retailers and along with non-food overseas internet purchasing by Australians, margins are being squeezed. But so far both overseas department store retailers plus the overseas food retailers like Costco have found it hard to get suitable sites. Aldi is the exception.
- The introduction of personal customer purchasing knowledge into marketing to individuals requires substantial retail investment, but those who undertake it will see dramatic improvements in their productivity. Woolworths, Coles, David Jones and Myer are all going full bore in this direction. Customers will receive product marketing via mobile devices directed to their personal purchasing patterns. This is not good news for existing marketing channels like newspapers, which will also need to adapt.
- The Australian online purchasing rate will explode in both food and non-food. Australian retailers, particularly Myer and David Jones, were asleep but are waking up.
- The increase in online non-food purchasing will take it from token levels to 10 per cent, 20 per cent, or 30 per cent of the market and will put enormous pressure on shopping centre rents. The big customer-attracting centres may be fine but Australia has too much retail space, particularly in strips. Currently shopping centres are offering short-term rent holidays.
- Currently we are increasing supermarket retail space, which is being constructed at an unsustainable rate. Woolworths is leading the charge, followed by Aldi and Costco. Coles is now joining in. This will reduce per store performance.