Retailers' Alcohol Risks

Supermarkets have all but wiped out the corner grocery store in Australia and now they’re moving on the liquor market in a big way. So is the $11 billion retail liquor industry about to be shaken or just stirred? Is the independent liquor store set to go the way of the general store? And if so, what will this mean for investors?

Over the past three years, supermarket giants Woolworths and Coles have gobbled up liquor retailers and pubs as they expanded their portfolios in a move unequalled since the corner store all but disappeared 20 years ago.

And Australian governments are not without a role in this rapid expansion of the titans, such as Woolworths and Coles Myer. Three years ago the Victorian Government decided to phase out the 8% limit on packaged liquor licences held by the supermarket chains. On January 1, it will lift all restrictions, completely exposing independent liquor retailers to the might of the supermarkets. And the floodgates are opening.

Woolworths now accounts for almost one third of all liquor sold to thirsty Australians. And they’re moving into pubs and liquor stores quicker than a wharfie can down a schooner.

In a strategically significant move, Woolies and the well-known pub owner Bruce Mathieson Group (Woolworths' 25% Bruandwo joint venture partner) recently paid $380 million to acquire Taverner Hotel Group. The acquisition of this portfolio of 33 pubs including 18 in Victoria, 12 in South Australia and three in NSW.

This was hot on the heels of Bruandwo's $1.3 billion purchase of pub and bottle shop owner Australian Leisure & Hospitality Group from Foster's in October last year. ALH operated 131 pubs and 6000 poker machines across five states.

Woolies’chief executive Roger Corbett now counts on more than $3 billion a year from the tills of his pubs and liquor stores. And he knows that the packaged liquor market is growing at almost twice the rate of packaged grocery.

What does this mean for Australia’s 8,000 hotels, clubs, taverns and bars and almost 4,000 packaged liquor outlets independents?

In a new report on the industry, Ernst & Young suggests that up to 50% of independent liquor retailers will not survive the removal of the cap in Victoria alone. "There is speculation in the industry that within five years, the major supermarkets could control up to 70% of the market," the report says. It also acknowledges the potential for an "effective duopoly" between Woolworths and Coles Myer that already control 50% of the market.

Coles Myer Ltd has 600 packaged liquor outlets and Woolworths about 1,000 including 35 Dan Murphy's stores. Wily retailer Roger Corbett is yet again outplaying non-retailer John Fletcher at Coles Myer. But this trend of market dominance by supermarkets had its origins when Corbett and Fletcher were just thinking about their first jobs.

In the 1950s, many grocery shops were converted to "cash-and-carry" stores and in 1960 both Coles and Woolworths opened their first supermarkets. Compared to department stores and variety stores, this is a pretty recent phenomenon.
According to the Australian Bureau of Statistics, in the late 1940s there were 18,577 grocers and mixed business in Australia, but by the 1990s that number had halved, to only 9,476 supermarkets and grocery stores.

The impact of the supermarket was, however, not restricted to grocery and mixed business corner stores. In the same period, the number of fruit and vegetable retailers declined by 27% and the number of fresh meat, fish and poultry retailers declined by 5%. Although these declines might not seem dramatic at first glance, they must be set against the fact that the total number of retail outlets doubled over the same period.

In 40 years, Coles and Woolworths have between them managed to secure more than half the total grocery market in Australia. And, in a much shorter time, they now own close to half of all the liquor outlets in Australia and must surely have set their sights set on the 70% predicted in the Ernst & Young report.

The liquor market is a good place for Corbett and Fletcher to play. The Australian market is more fertile than for example, the US. In Australia, 75% of adults drink alcohol, compared with 68% in the US. And of all those who drink alcohol, 72% of Australians and only 33% of Americans drink wine.

This thirst for the good drop translates directly into sales at the retail level.

New data from Roy Morgan Research indicates that a quarter of Australians (27%) say they bought liquor from a licensed supermarket in the past month, while 20% say they bought from an individual retailer; 4.7 million Australians bought liquor in the past seven days, paying an average of $29 each.

The supermarket giants own almost half the "individual retail" stores, like Dan Murphy's, so they are charging towards market dominance. A quarter of a million consumers bought from Dan Murphy’s in the past week, spending $49 each.

But what lessons can be learned from their road to grocery dominance?

As we all know, market dominance can give rise to anti-competitive behaviour by supermarket chains, with below cost or unreasonably low pricing to the detriment of the independents.

The Grocery Pricing Report issued by the Australian Competition & Consumer Commission highlights several competition issues facing the Australian grocery industry, questions that are intensely relevant to supermarket-dominated liquor industry '” including the lack of supplier power and possible intimidation of suppliers; and the impact of creeping acquisitions.

Competition on prices can be good news for consumers, but the retail margins achieved by Australian supermarket liquor operators is 3–4% compared with closer to 8% in the US. So it’s a fairly safe bet that the wine and beer producers and spirits distributors are the ones being squeezed by the supermarket chains.

This obsession with price goes hand in hand with the supermarket culture and can be a dangerous strategy, particularly given that factors other than price influence consumers to purchase wine. Shareholders in both Woolworths and Coles Myer would have to be concerned about attempts to commoditise products in an industry that is already suffering low margins. If the sorry saga of Southcorp has a lesson for the big two retailers, it must be that cutting prices can ultimately hollow out profits inside the industry.

In fact, new market intelligence reveals that of all key influencers on purchasing wine from a retailer, price comes fifth and "specials" comes seventh. Everyone wants a fair price, but to hear a buyer for the supermarket behemoths negotiate, you’d think price was all that mattered.

Brand and region-of-origin matter more than price and what better recent example of the folly of a price obsession could we have than the near disaster of Southcorp, acquired in May by Foster's for $3.2 billion?

Southcorp managers had been the custodians of some of Australia’s great brands including Penfolds, Lindemans, Seppelt, Queen Adelaide, Seaview, Wynns and many others. Following the acquisition of Rosemount, they used heavy discounting to generate volume and in just one year dropped almost a billion dollars from the bottom line.

But lessons are slow to be absorbed in the corner office and now we have the supermarkets, given a taste of blood, baying for more and more discounts.

When will the lieutenants of Corbett and Fletcher learn that consumers buy on factors other than price? Take another look at the Dan Murphy's retail chain owned by Woolworths. It’s a safe prediction that management meetings are dominated by discussions about price competitiveness, rather than chat about the romance of this region or that.

The most active drinkers in Australia are a group known as the "new economic order" (NEO) and the least frequent consumers of beer wine and spirits are known as Traditionals. Of the four million NEOs in Australia (24% of the adult population), 71% purchased wine in the past four weeks. Traditionals, on the other hand, are 50% of the Australian population but only 41% bought wine.

NEOs are 70% more likely than the general population to shop from Dan Murphy’s and twice as likely as Traditionals to call Dan Murphy’s their local.

Yes, NEOs are attracted to the case prices at Dan Murphy's, but '” and here’s the big news '” they know what brands they want before they get to the store! They’ve made decisions on brand, taste, variety and region long before they look for the best price.

Did Southcorp teach the industry nothing?

We will continue to see wine industry rationalisation with smaller brands being bought out by the major players. Among the handful of listed wine stocks left in the market, there is likely to be further consolidation. Among the list below, only Constellation Brands is an obvious aquirer.

• Constellation Brands (formerly BRL Hardy) – (ASX code: CBR)
• Dromana Estate Limited – (DMY)
• Evans & Tate – (ETW)
• Fosters Brewing Group – (FBG)
• McGuigan Simeon Limited – (MGW)
• Peter Lehman Wines Limited – (PLW)

Of the 3,000 table wine brands in Australia, 100 brands account for 50% of the market. Foster's owns many of the brands in that top 100 and is committed to its future as a global wine producer.

The simultaneous commitment to liquor by the big two supermarket companies has a spooky effect when studying their share prices and comparing them to Foster's.

The stockmarket performance of all three has become more closely linked as the supermarkets have expanded their liquor empires, with Woolworths and Foster's tied on the bourse and Coles Myer not far behind. Investors should keep a sober eye on who wins the race to liquor supremacy. In many ways, the tandem movement of these stocks reflects other oligopolies such as banks.

However, dominance may not be as profitable in liquor as in banking. There is no question that supermarkets will dominate liquor retailing in Australia. This is good news for investors in either Coles Myer or Woolworths. But will the price of success be too high?

Too high for the corner specialty liquor retailer who knows your name and knows your likes and dislikes, and who may well disappear in this rush to supermarket dominance.

Too high for the winemakers, who care about the beauty and provenance of what they do as they are squeezed mercilessly on price by faceless people who are so blinded by the allure of the checkout that they can’t see that it is beauty and provenance that sells wine.

Time is essential for the development of great wines and also helps our thinking mature. Here’s a few things to watch over time from the safety of the cellar.

• The three leading liquor stocks '” Foster's, CML and Woolworths '” are racing for domination but the risk is that domination will shrink margins and flatten profits.

• ACCC alert. Keep an eye on ACCC interest in predatory behaviour or potential market dominance by either of the big supermarket companies. They both make a point of saying that their market shares in the grocery market are below international levels, but never mention the high levels of dominance they are achieving in the liquor market. Any activity by the ACCC will impact share prices.

• Wine watch. Analyse the performance of listed wine companies carefully. Watch for Southcorp-type discounting in response to either too much volume; or too much pressure by the supermarkets.
• Act locally. Think about investing in wine companies but certainly invest in their best products. Go to Vintage Cellars and Dan Murphy's for predetermined case purchases, but stick with your local specialist for all that advice and great service; make the most of it while you can. They may not be there for long.

Ross Honeywill (ross@customerstrategy.com.au) is an internationally published author and a foundation director of consumer think-tank the Centre for Customer Strategy. Unless otherwise stated, data used in this article is drawn from Roy Morgan Single Source and is subject to copyright.