How game theory can save Woolworths: Part II

taskThis column is part two in a series discussing game theory and how it could aid Woolworths’ turnaround strategy for its supermarket business. Click here to read part one in this series.

Brad Banducci and the board of directors at Woolworths may very well be facing a Sisyphean task in rebuilding Woolworths’ supermarkets. Let me explain using economics.

In 2001, when Aldi opened their first store in Australia, then CEO of Woolworths, Roger Corbett, and his executive team were not overly concerned. Aldi was not viewed as a threat. The fact Corbett failed to recognise the potential threat of Aldi is interesting for several reasons. During the years Corbett was CEO, Woolworths lacked any real competition in Australia. Coles was not a major competitor.

Aldi, however, had a proven history of success and an established, global reputation for low prices and flawless store execution. To this day, many analysts continue to question why Corbett did not design and implement a full-scale strategy for competing against Aldi, such as a sustained policy of competing on quality and setting the opening price point on specific products/categories.

A potential reason for explaining this could be that Woolworths was emulating strategies being utilised to great success by Walmart, and it was Corbett’s vision to turn Woolworths into the Walmart of Australia, and Aldi was not a priority.

Based on my thorough review of Corbett’s tenure as CEO of Woolworths, and based on Aldi’s current level of success and projected future growth, Corbett and his executive team from 2001 to 2006 had the best opportunity of depriving Aldi of success in Australia. Simply put, by allowing Aldi to set the opening price point on the 20 per cent of lines producing an average of 80 per cent of the sales in a supermarket, Woolworths effectively abdicated their position as the ‘Every Day Low Price’ leader.

aldiIn addition, by failing to implement a strategy that assured consumers that Woolworths had the freshest products available of any supermarket or discounter in Australia, Aldi was able to market that their quality was on par with that of Woolworths and others. When given a choice of shopping for quality products at low prices, consumers increasingly turned to Aldi. As Aldi became more popular, its management team invested heavily in growing the brand and gaining economies of scale as additional stores were opened.

When Corbett retired in 2006, Michael Luscombe became CEO and he held the position from 2006 until 2011. Luscombe’s also failed to recognise Aldi as being a threat to Woolworths. To his credit, Luscombe was focused on expanding Woolworths into the home improvement sector instead of focusing on Aldi. Code named ‘Project Oxygen’, expanding into home improvement was supposed to suck the oxygen out of Wesfarmers’ turnaround of Coles by forcing Wesfarmers to invest more capital and efforts into Bunnings and taking the focus off of Coles supermarkets. Clearly, the decision to enter the home improvement market was an error in strategy.

Grant O’Brien became CEO in 2011 and continued with the home improvement strategy and battling Coles. Only peripherally within the company was the threat of Aldi becoming recognised, yet still no strategy was put into place to confront the Aldi threat head-on.

Deterrent with credible commitment
Failing to recognise the threat of Aldi by a succession of Woolworths CEOs proved to be a potentially fatal mistake on the part of Woolworths. The lack of focus by Woolworths CEOs on Aldi allowed Aldi to grow in Australia at an accelerated pace. Woolworths should have implemented a strategic movement known as Deterrent with Credible Commitment, whereby Woolworths, through its actions, would convey to Aldi that under no circumstances would Woolworths allow Aldi to be the everyday low price leader for groceries.

Woolworths WaterstonesWoolworths could have conveyed that message to Aldi by identifying the store expansion strategy that would most benefit Aldi. In turn, Woolworths could have opened small format stores similar to Aldi and saturated the geographic regions where Aldi could potentially operate. Such a strategy would have made it more difficult for Aldi to differentiate its business model, reduce demand for a new low-cost entrant, and force Aldi to compete on price much faster than anticipated.

A deterrent movement with credible commitment using harsh competition would more than likely have deterred Aldi from entering additional cities and made store expansion more difficult. The effect of such a strategy would also have reduced interest in Aldi by Australian consumers who would have found little incentive to switch to Aldi from Woolworths. The problem now facing Woolworths is that they didn’t implement a deterrent strategy with credible commitment using harsh competition in 2001. That made it easier for Aldi to expand and increase the demand for a new low-cost alternative to Woolworths and Coles.

Although ALDI is in a much stronger position in 2016 than 2001, the game that Woolworths, Coles and Aldi play is essentially a repeated game where in every new city, a new strategy has to be picked related to store location, number of stores, pricing, and competitive strategy. Due to the maturity of Coles’ store network, Woolworths has fewer strategic options they can utilise against Coles.

Hope yet for Woolworths?
However, Woolworths hasn’t lost all its leading/advantageous positions in the cities where Aldi hasn’t opened stores. Woolworths can still send a message to Aldi that it is up for competition at any cost. By “message”, I mean a deterrent strategy with credible commitment.

Due to the financial impact of Masters; the continued investing in prices to the tune of $400 million with an additional $150 million slated; and the fact Woolworths would have to invest hundreds of millions of dollars, if not in excess of a billion dollars or more, to design and open smaller stores, finances may prevent Woolworths from actually implementing a deterrent strategy with credible commitment. This leads to the importance of Woolworths reducing costs. The more that costs can be reduced, the easier it is to secure loans and free up capital to be invested in a deterrent strategy with credible commitment.

Another issue facing Woolworths is the issue of competing on price with the leading discount grocery retailer in the world, Aldi. In discussions with Dr. Jan Van Mieghem, Kellogg School of Management, Northwestern University, regarding Woolworths and game theory, Dr. Van Mieghem stated that, “Woolworths and Aldi are not head-on competitors, but rather pursue differentiated positions in the space of cost and X (where X represents choice, variety, quality, and service). My suggestion would be that Woolworths must decide whether to differentiate further/better, or whether to compete head-on with Aldi.”

Compete head on with Aldi or differentiate – which strategy is best for Woolworths? Stay tuned for part three of this series.

Brittain Ladd is a business strategist and retail commentator and can be contacted at bcladd48@gmail.com. This column is part two in a series discussing game theory and how it could aid Woolworths’ turnaround strategy for its supermarket business. Keep an eye out for part three shortly. Click here to read part one in this series.

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Comments

1 comment

  1. drew posted on July 20, 2016

    Unlikely Aldi would have been deterred from expansion if Woolworths moved first - seems like they were intent on Australia as a growth strategy. If Woolworths had saturated the areas where Aldi could potentially operate, it would have created a Nash Equilibrium and reduce Aldi's traction but I don't think it would have stopped expansion - it would have been the right strategic move for both companies. For mine, I think a major wrong step by Woolworths was the investment into more home brand products to create a value price point - this legitimised the quality of home brands for Australians and Aldi was able to leverage this perception to implement the business model that worked so well for them in Europe. If Woolworths focused on delivering branded products at cheap prices, it may have created more sustainable differentiation from Aldi, and making the consumer choose the pay off between branded product vs price.

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