Aldi is now the most profitable supermarket retailer in Australia, with EBIT at six per cent, against 4.6 per cent reported by Coles, and 5.4 per cent reported by Woolworths. On top of being more profitable, Aldi also retains prices at a level 20-30 per cent below that of Coles and Woolworths.
Clearly Aldi is outperforming the incumbent supermarket operators. To understand how such a performance gap is possible between seemingly similar shop formats, consider just one critical factor: the strategic time horizon.
With publically listed parent companies, Coles and Woolworths are subject to appeasing board members and shareholders, meaning both businesses are perpetually preoccupied with the current financial year. On the other hand, as a private company Aldi has the freedom to pursue a long-term strategy religiously and avoid reacting to short-term market sentiments. And there aren’t many retailers, private or public, that are run as well as Aldi or boast the German company’s pedigree in foresight and planning.
Another influential factor in Aldi’s ascension started back in the 1990s when Coles and Woolworths began to squeeze their suppliers and expand home brands, which reduced the choices available on their shelves. In short, they progressively achieved Aldi’s product cost levels, yet retained high prices to satisfy the share market. However, this extra gross margin seems to have been wasted on excessively expensive projects, which created ongoing interest and operating expenses.
So, it was Coles and Woolworths that inadvertently created the current environment for Aldi to thrive in. They reduced their merchandise offer, but failed to reduce their cost base, forcing them to retain high prices. The rest is history – Aldi can sell their goods for much less and still make more money than Coles and Woolworths.
Independent supermarket operators face additional problems. As a collection of separately owned businesses, they are forced to rely on a shared supply chain over which they have no control (ie, Metcash). Such a business model leaves them with little chance of successfully competing against their large corporate rivals.
What does this mean for the supermarket segment over the next few years? The key conclusions that can be drawn are:
- The structural problems at Coles and Woolworths are unfixable. They cannot ‘unspend’ the money spent buying excessively expensive computer systems or over-refurbishing stores.
- Aldi will continue to win business at the expense of Coles, and Woolworths, making them less profitable. The duopoly will not be able to shrink their fixed cost basis at the same rate as their receding market share.
- Coles and Woolworths will need to reduce their prices, although they will never be able to match Aldi’s price levels.
- The Aldi-Coles-Woolworths dynamic will, in turn, increase the pressure on Metcash and independent supermarkets.
- In defending their gross margins, Coles and Woolworths will try to do more of the same. They will apply increasing pressure to their suppliers, forcing some of them out of business. There simply isn’t any blood left in those stones.
- Costco’s expansion will add to everyone’s pain.
As a consequence, by 2020 we could feasibly see Coles and Woolworths sharing 60 per cent of Australian supermarket sales, while Aldi jumps to 14 per cent market share, leaving Costco at around six per cent, independents at four per cent, and online and specialty supermarkets at 16 per cent. I expect Aldi to gain more market share than has been speculated elsewhere in the media.
This all adds up to a sorry tale for Coles and Woolworths, but a catastrophic one for the independents. Unfortunately, the strong, structure-driven trends are unlikely to change. This is not a mere market fluctuation that will self-correct itself in time.
Andrew Gorecki is managing director of Retail Directions and a 30-year veteran of the Australian retail industry. He can be contacted at Andrew.Gorecki@retaildirections.com.
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