How game theory can save Woolworths: Part I

Woolworths, shopper, supermarket, mobileThe odds are high that Coles and Woolworths would have continued with their market domination if not for Aldi’s arrival back in 2001. Unlike traditional grocery supermarkets that can stock 40,000 or more SKUs on their shelves and who focus on selling and stocking the leading brands in every category, Aldi is the world’s leading discount retailer that stocks only 1350 core items and focuses on selling their own high-quality, private label brands.

With a corporate philosophy that states “All people, wherever they live, should have the opportunity to buy everyday groceries of the highest quality at the lowest possible price”, Aldi has found success operating over 9000 stores in 18 countries.
In Australia, Aldi was viewed by analysts and executives at Coles and Woolworths as being nothing more than a niche player that would find only minimal success. In discussions with former executives at Woolworths, I frequently heard the phrase “we thought they would fail” when discussing Aldi.

Obviously, Aldi didn’t fail. According to an April 18, 2016 Roy Morgan Research report, Aldi’s share of the Aussie market is still rising with a 12.1 per cent market share operating just 400 stores compared to Coles and Woolworths operating a combined 1760 stores. Morgan-Stanley estimates that Aldi will achieve sales of $15b by 2020.

Based on a review of the leading grocery retailers globally, and my first-hand experience consulting to grocery retailers, I consider Aldi and another German discounter, Lidl, to be the two best grocery retailers in the world. Aldi is on a path to becoming the largest grocery retailer in the world.

The danger and challenge facing Woolworths is that it must find a way to compete against a traditional supermarket, Coles, and a discounter, Aldi.

Since becoming CEO, Brad Banducci has ordered a review of all areas of the company and has continued with Woolworths’ policy of reducing the price of items in Woolworths’ stores to better compete with Coles and Aldi. Over the last nine months, Woolworths has reduced prices by over $400 million with plans to reduce prices an additional $150 million in 2016. Reducing prices has not sufficiently increased sales.

Woolworths is in a world of hurt. Coles had comp store sales of 4.9 per cent for the month of April 2016, while Woolworths experienced a decline of 0.9 per cent. Woolworths also lost customers to Coles and Aldi. The fact that Woolworths is the market leader in Australia is meaningless if all signs point to a continued decrease in sales and lost market share. And Aldi’s ability to take market share from Woolworths is a foreboding sign.

While Banducci is looking at a three to five year journey to rebuild Woolworths, Woolworths does not have three to five years up its sleeve for said rebuild.

Game theory
If ever there was a retailer that should invest the time and effort to apply game theory and the science of strategy to identify their corporate strategy, it is Woolworths. When applied correctly, game theory is superior in identifying the optimal strategy for a corporation to follow – especially when a corporation is faced with competitive threats from new entrants.

This is not to say that other strategic frameworks aren’t valuable, but game theory provides better results. Game theory is like a crystal ball in many ways as it helps companies understand the impact of decisions made in the present on future operations and market position.

The game theory modelling I’m advocating here provides executives with the advantages and disadvantages of strategic options at different progressions. Additionally, the model finds the ‘best fit’ option considering upside potential and downside risks under all likely scenarios, assumptions, variables, and sensitivities (such as price). This approach is different from attempts to look for equilibrium in an artificially simplified world in traditional game theory modelling.

I applied game theory to evaluate whether or not Woolworths should divest or retain its 500 Caltex service stations and convenience stores. The modelling was not limited to making a decision based on cost savings or possible revenue generation through a sale. Instead, I ran multiple scenarios and considered many variables in conjunction with a strategic framework. Based on the results from game theory modelling, the optimal strategy would be for Woolworths to retain its Caltex stores but implement a strategic model that utilises the stores differently than they’re being utilised today, as doing so would give Woolworths an advantage over Coles and Aldi.

Based on my analysis, Woolworths should only divest its Caltex convenience stores after it has completed game theory analysis, so as to identify the impact of divesting Caltex on its overall market strategy. On the surface, divesting Caltex and generating $1.3b to $1.7b from a sale may seem like the best option. However, game theory modelling and analysis would help Woolworths better understand the strategic impact of leveraging their Caltex convenience stores more strategically, versus simply jumping at the chance to generate cash from a sale.

I also applied game theory to Woolworths private label strategy. The results are clear: Woolworths needs to greatly diminish its focus on private label as it will never be able to compete with Aldi – the master at private label retailing.

Brittain Ladd is a business strategist and retail commentator.

This column is part one in a series discussing game theory and how it could aid Woolworths’ turnaround strategy for its supermarket business. Keep an eye out for part two next week.

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