on of reducing your merchandise offer to protect market share sounds strange. But, the strategy problem at Coles runs deeper than that. Let me take you on a short trip down memory lane. In the mid-1980s, Coles’ supermarket operations came under pressure from low-cost operators in Bi-Lo in South Australia and Shoeys in NSW. I worked for Bi-Lo at the time, and it was hard to believe the level of excessive expenditure in Coles’ stores, and in its technology department. Competing with such an inefficient operator was relatively easy. New Bi-Lo stores were profitable from day one, while Coles stores apparently needed two to three years to reach break even point. How did Coles respond to the Bi-Lo challenge? It opened a chain of stores called Price Point, intended to be a low-cost operator, to stop discounter Bi-Lo in its tracks. As you can guess, Coles couldn’t make the formula work. Taking the ‘if you can’t beat them, join them’ approach, Coles acquired Bi-Lo and absorbed the ill-fated Price Point stores into the Bi-Lo chain. Next, Coles bought the Shoeys store network, which it also later rebranded as Bi-Lo. These moves gave Coles presence in the lower end of the market, pitching it against Franklins and Jewel supermarkets. So far, so good. But, Coles, being Coles, couldn’t resist making Bi-Lo “better”, in the process progressively eroding the low cost base within the business. It took about 15-years for the operating models of Coles and Bi-Lo to converge – until both businesses offered the same merchandise and had the same cost base, but Bi-Lo sold its stock for less. To address this apparent anomaly, Coles rebranded all Bi-Lo stores to Coles and increased prices accordingly. In some shopping centres, this led to ridiculous situations where two Coles supermarkets operated side-by-side. These missteps allowed Aldi to enter the market, but the German discount operator remained a minor player until Coles (and Woolworths) made another strategic blunder, which cleared the path for Aldi to blossom. Coles progressively eliminated branded merchandise to the point where home brands constituted over 30 per cent of its product offering. You don’t need a science degree to figure out what this means long-term. If you mostly sell your home brand (like Aldi does), and your prices are 20 per cent to 30 per cent higher, and your EBIT is 25 per cent lower, you have little hope of succeeding. By killing off Bi-Lo and at the same time by becoming a provider of expensive generic stock, Coles created the perfect conditions for Aldi and subsequently Costco to grab a substantial market share. And both of these astute operators gladly obliged. David Jones’ supermarket push Things can only get worse from here. By moving downmarket, Coles (and now Woolworths) have created an opening in the higher end of the supermarket sector. David Jones already has the ball rolling on its entry into the supermarket business. David Jones’ supermarket offer is expected to be more upmarket, with the kind of merchandise choices that Europeans typically enjoy in their supermarkets. And in late 2015 David Jones’ South African owner, Woolworths Holdings Limited, signalled how serious it is about establishing a leading high-end grocery presence by swapping then incumbent CEO, Iain Nairn, with John Dixon, the former chief of Marks & Spencer’s $9.7 billion food business in the UK. As a result, over the next five years Coles’ EBIT will come under a tightening squeeze, as it continues to shift into a market segment where it cannot compete, abandoning some of its current territory to David Jones and the surviving independents. Is there an alternative for Coles? There would be if it could execute a rational strategy aimed at creating a leaner business. But its corporate inertia will likely make this impossible. Coles would have to completely redefine its business processes to reduce its cost of doing business to levels that would deliver 10 per cent EBIT, and at the same time provide well-priced, branded merchandise. Coles should aim to firmly occupy the middle of the market and challenge the lower and higher ends through excellent execution. But, I doubt this will happen. Instead, Coles will likely struggle to generate decent shareholder returns and will lose further market share as it drifts into the discount grocery territory. At some stage, it may even be fitting to drop the pretences and rebrand Coles to Bi-Lo. Some of the old signage may still be laying around.