The competency question falls over Woolworths

Woolworths' hardware foray is a $2 billion play yet the company appears to have fumbled the basics of a retail offering. It's the second major blot on Woolworths' recent copybook.

The most striking, and disturbing, aspect of yesterday’s disclosure by Woolworths of the blowout in losses from the Masters hardware joint venture was its admission that it didn’t know a lot about the business when its budget was set for this financial year.

Woolworths’ attempt to break into the hardware sector in partnership with US hardware group Lowe’s was announced in 2009 after a lengthy evaluation of the sector. Three years later, when the 2012-13 budgets were being framed, it didn’t understand the sector? No wonder the Masters’ business, budgeted to lose $119 million, lost $157 million and the Danks business, budgeted to make $38 million, lost $18 million.

Of greater consequence than the losses themselves – which, for an ambitious start-up and in the context of a group that earns more than $2 billion a year, are manageable – is the loss of credibility for Woolworths.

When its management confesses that it didn’t understand the business, that it didn’t know a lot about "seasonal curves" and the fact that seasons in the southern hemisphere are different from those experienced by Lowe’s in the northern hemisphere, you’ve got to wonder about its competency.

What Woolworths, which owns two-third of the joint venture, admitted to was that it was over-optimistic on sales budgets, wage costs and margins, which it said were lower than expected because of the sales mix.

In other words, it got its revenue, costs and product offering wrong – the basic elements of a retail offering.

Woolworths’ performance in its core food and liquor business has, for a long time, been stellar. Paul Simon re-built the supermarket business in the late 1980s and early 1990s and Roger Corbett supercharged it.

They were aided by the ineptitude of their major competitor, the old Coles Myer group and the extent of the resurgence of Coles under Ian McLeod since Wesfarmers acquired Coles, Kmart and Target would suggest that the under-performance of Coles beforehand is part of the explanation for the out-performance of Woolworths.

However, while Coles has, in a relative sense, out-performed the Woolworths supermarket business since McLeod and his team began turning their numbers around, no one would dispute Woolworths’ excellence as a food and liquor retailer and Grant O’Brien has re-ignited some momentum in the business since he became Woolworths’ chief executive.

Woolworths, when it decided to launch into hardware with a plan for a $2 billion, 150-store attack on Wesfarmers’ retail powerhouse, Bunnings, thought Wesfarmers was vulnerable and that by undermining Bunnings’ profitability it could destabilise its major competitor.

It would now appear that it both misjudged the capabilities of both the Coles’ team and Bunnings’ John Gillam, who was well aware that Woolworths was planning to come after his business. Yesterday’s disclosures would also tend to suggest that Woolworths simply didn’t do its homework and was over-confident about its own competency.

With the announcement of Masters’ losses Woolworths also announced that it had wound up an agreement with Anchorage Capital which would have given it a share of any upside from a future of the Dick Smith electronics business that it sold to the private equity group last year for $20 million – after writing off more than $400 million. Woolworths will end up with $94 million for that business.

Dick Smith was the first major blot on Woolworths’ copybook in the post-Simon era. Despite several changes of format and offering it was never able to make the business work and essentially ended up giving it away to Anchorage, which appears very encouraged by its post-purchase performance.

The early disappointments in the Masters’ business, and the failure to fix Dick Smith, raise the question of whether, while being an excellent food and liquor retailer, Woolworths’ core competencies don’t extend any further than food and liquor.

The Big W chain has generally performed quite well over a long period – but that may also have been due to the poor performance of Kmart when it was part of Coles Myer. Under Guy Russo, it has staged a remarkable turnaround – and sideswiped both Big W and its own Wesfarmers’ sibling, Target.

Woolworths and Lowe’s pitched Masters, a big box format, upmarket of Bunnings. They are rolling out more expensive stores in less attractive locations, because of Bunnings’ decades of head start. And they have an offering that is tilted towards discretionary shoppers – Bunnings gets those, but it also attracts trade and DIY shoppers.

It will be a test of Woolworths’ management whether it can get the Masters’ strategy back on track and achieve its stated objective of getting the business to break-even by 2016.

If it could do that it would redeem its reputation; if it can’t – and hardware is a $2 billion play with serious financial consequences if it doesn’t work – there would be a serious and destabilising question-mark over the ability of the group to successfully compete outside food and liquor.