PORTFOLIO POINT: Coles’ new flybuys scheme suggests the battle between Woolworths and Wesfarmers is about to heat up – and there are important implications for shareholders.
This week, along with 8 million other Australian households, the Gottliebsens received a Coles flybuys card in the mail. In total, Coles sent out 16 million pieces of mail via Australia Post. With one exception, Australia has never seen a mail-out on this scale before.
At Eureka Report, we believe it’s important to alert our readers to fundamental changes taking place in our business community. The Coles mail-out heralds such a shift.
Sometimes at the beginning of these changes it is difficult to work out the right investment strategy, but let’s have a try. Most of you would also have received the Coles flybuys offer, which consists of an attractive reward plus 10% off your five favourite purchase items at Coles supermarkets.
That offer is part of a massive attempt by the CEO of Wesfarmers, Richard Goyder, to establish the best consumer database in the land.
At the time of writing, it would seem the response by the Australian community has been very favourable and at one point, 200,000 cards were being activated per hour. The last time we saw a mass mail-out on that scale was in 1974, when the big banks combined to offer most Australians a credit card with a $300 limit, called Bankcard. It came unsolicited in the mail and heralded the credit card boom which changed the way we shopped. The Coles exercise is actually bigger than Bankcard and will also fundamentally change retailing of goods and services. Woolworths has its own strategy to entice customer loyalty and it too will develop a database of enormous proportions, but Coles is doing it in one hit.
The Coles strategy is aimed at finding out not just the email addresses and names of its customers, but more importantly what their favourite purchases are. With this information, Coles will begin the process of working out what sort of offers to put to individual customers.
Let me take you down the proposed Coles track: You will find that Coles customers who like, say, corn flakes, will receive specials in that area. Even further down the track, when these customers are walking past the corn flakes aisle, their mobile phones may ding an SMS to indicate there’s a particular special they may be interested in. And it goes further: As they learn more about these customers, both Woolworths and Coles are going to step-up the products they offer to their customers; it will go way beyond groceries and fresh food. Coles and Woolworths are already into insurance; Woolworths is dabbling in banking and, of course, has its link with Qantas. This is merely the beginning. In time, both companies will perhaps offer hardware from their Bunnings and Masters chains. Clothing will be brought into the customer base nets.
The banks, via their credit cards, had the opportunity to capture customer data and market a whole range of services and goods. They didn’t take that opportunity, partly because of conflicts of interest and ethics in banking. In addition, the technology was not as advanced a decade ago.
There will be no such restraints among the supermarkets and they are going to look for goods and services to market to the amazing databases that both companies are assembling. I suspect that the sheer magnitude of the Coles mail-out will cause them to generate a better database than that of Woolworths. If that’s true, then this is a seismic shift from Woolworths to Coles. But it is much too early to make that prediction – we will need to watch developments.
Both these companies are going to be very profitable, although they have different strategies. In the case of Woolworths, the company is investing enormous sums in a bricks-and-mortar expansion through its Masters hardware chain, to take on Bunnings and Harvey Norman.
Woolworths is also doubling its bricks-and-mortar bets with a massive expansion of its supermarket network. And these two strategies have caused the company to raise over a billion dollars in bonds and hybrid securities. Woolworths has an enormous cash flow but is highly leveraged, because in addition to its debt, it has very large lease obligations which are a disguised form of borrowing (being future commitments to pay money to freehold owners). But Wesfarmers is also highly leveraged.
Woolworths’ bricks-and-mortar strategy had better work. Clearly, there is no better supermarket operator than Woolworths and I would be very confident that its new supermarkets will do well. I am much less confident about its challenge to Bunnings and Harvey Norman, as Woolworths does not know a lot about these retail areas. It is very risky to have two major expansion programs involving bricks-and-mortar taking place at the same time.
In the case of Coles, the group is undergoing a much more restrained bricks-and-mortar expansion of its supermarkets. It has instead chosen this massive mail-out to drive customer expansion, some of which will be served by online selling. To some extent, it’s a 'clicks versus bricks’ battle. We know bricks work, but clicks are a lot less expensive despite the cost of the mail-out.
However, when it comes to hardware, Wesfarmers/Bunnings are going for bricks and will match Woolworths store-for-store. Bunnings will be more than twice the size of Masters when the Woolworths expansion is complete.
These are two companies that are at each other’s throat – in food, clothing and hardware. And this rapid expansion may affect their earnings in the short term. But out of it is going to come enormous market power and in due course, they will use this market power to greatly increase shareholder returns. In investment scenarios, both Wesfarmers and Woolworths should be part of any long-term portfolio. I tend to favour Wesfarmers, mainly because I am concerned about Woolworths’ ability to take on Bunnings. On top of this, Woolworths is not finding it easy in the Big W arena, where it is up against some very skilled operators in Target and Kmart (also owned by Wesfarmers).
The sheer audacity of sending out so many letters via Australia Post shows a dedication to customer base marketing that we have never seen in Australia before.
I can remember, several decades ago, the then-chief of Coles supermarkets Dennis Eck dreaming of such a world. It’s now about to be a reality and is going to generate very large profits for both retailers, but I suspect the mail-out and the 10% discount on five favourite items will give Coles the edge. Of course, you can’t buy Coles or Bunnings shares, so you must buy Wesfarmers to be part of the game. And that puts you into coal, which has a totally different set of scenarios. The coal business has of course been very beneficial and Wesfarmers was right in not selling when the market was down. But what a magnificent company it would be if it sold its coal interests and concentrated on this amazing retail strategy, using a lower capital base and much less gearing.
What is important, however, is not so much to concentrate on the war, but to understand the power that these companies are going to generate. In a strange way, we expected the banks to be able to take advantage of the fact that there are only four major players, and win well as a result. They did win, but not as much as they would have expected to, because of their dependence on overseas borrowings to fund their loans. Now the opportunity that the banks had is being taken over by the retailers.
On the other side, those companies that are suppliers to retailers will need to be right on their game and understand the power of these corporations. We are going to see a lot of food companies shut their plants. Many of those plants have bad work practices and old equipment. They will go to New Zealand or elsewhere in the world to avoid their Australian base problems. Out of that will emerge a series of new food processors – often backed by the supermarkets – that will be modern and use flexible labour practices. Accordingly, we are going to see a big change in our industrial structure. And the same thing will happen in the service sector. You are going to have to be very good in the banking, insurance and perhaps even accounting areas, as these supermarkets seek to 'clip ticket’ as they give access to their fantastic databases. This has all the earmarks of being a major shift in profitability in both the service sector and the goods sector, as the power of these customer bases becomes more and more apparent. Meanwhile, Metcash will be at a disadvantage because it doesn’t have that same customer base power. It will need to be extremely clever in picking local markets and trying to engender loyalty with specialised products and other techniques that the local supermarket can actually develop without the aid of a database. It will be a different game.
Small shopkeepers that currently prosper alongside supermarkets will need to be very good. There will be many community protests about the dominance of Woolworths and Coles, but they will have little impact. The databases being assembled by these two retail powerhouses mean their dominance will be there for a long time.