There has been a lot of commentary about Coles’ improved performance when compared with Woolworths’. Stephen Bartholomeusz enthuses about the “renaissance of Coles” although he is careful to say that Woolworths is doing alright as well. Elizabeth Knight enthuses about the “dazzling sales number from Coles raises the stakes in the mother of all supermarket battles between it and Woolworths”. Brokers, meanwhile, are getting sceptical about Woolworths’ strategy. But what is not getting much attention is that this is an uneven competition. One company, Woolworths, is just a retailer and mainly in supermarkets. The other, Wesfarmers, is a conglomerate. It is an intriguing battle between the relative merits of sticking to your knitting and having a portfolio of industries and options.
The first phase of the battle was always going to belong to Coles. It is simply a reversion to what should be a typical norm. In a duopoly, if both sides are reasonably competent they should get roughly equivalent market shares. Any competitive initiatives, especially if based on cost, can quickly be copied and will not offer long term advantage. Woolworths has thrived because Coles was so badly run. Even half way reasonable management was going to change that, and Wesfarmers has a pretty good record of management that is far better than just “reasonable”.
Macquarie is one of the brokers getting worried, with an underperform rating and a price target of $26.90:
Woolworths’ food and liquor doesn’t have an obvious differentiated strategy for dealing with competition. Copying Coles is the most creative WOW has gotten. WOW seems to be getting beaten on two of the five key retail value attributes: price and service. Access and experience are at risk. Changes in leadership at WOW have encouraged a whole raft of trade views about what is wrong including: the wrong KPIs driving behaviours, an absence of customer centricity in ranging and pricing, reduced store level service, poor consumer insights capability and under utilised loyalty capability.
None of this is likely to be new. Woolworths’ differentiation in the past was probably that it wasn’t a complete debacle like Coles. Its reputation for being a well managed company was strictly relative to its opposition. That is what happens in duopolies.
So now that we have two roughly equal competitors, what is likely? Woolworths is not reinvesting as much in its core supermarket operations to keep its core advantage (as implied in the Macquarie comment). Instead, it is trying to develop more operational scope in areas like hardware, aware that its competitor has a great deal of scope across many industries.
Whether this is a good move could be argued either way. The Wesfarmers hardware chain, Bunnings, is a huge cash cow with superb margins for a retailer owing to its monopoly. The hardware area is likely to be somewhat shielded in the event of further housing weakness because renovations tend to remain strong when poeple move less. And, hardware is still retailing, so it’s not too far from Woolworths core business.
But defence in an area where Woolworths is weak rather than continued attack in an area where it has been strong doesn’t sound all that clever. My conclusion is that Woolworths would be better working out how to maintain profitability from what is likely to be a smaller market share, rather than “beating” a very different opponent at its own game. After all, both companies will have no trouble attracting institutional investors.
Macquarie questions the pursuit of scope. This chorus of criticism is likely to get louder.
In our view, change is required at WOW to deal more effectively with competition in all its businesses but F&L in particular. Is CEO designate O’Brien a change agent? We don’t know yet. While we wait to find out there is increasing uncertainty around earnings growth into FY12 and a large and unquantified risk associated with its market segmentation strategy into DIY/Home Improvement.