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Tristan Kitchener
Expert
+ About Tristan Kitchener

About Tristan Kitchener

Tristan Kitchener is an expert on the grocery retail sector, and provides support to businesses along the whole value chain from retailers through to manufacturers, producers and growers.

How the Germans are winning the supermarket war

Thursday, August 30, 2018

There has been a resetting in consumer’s attitudes post the global financial crisis (GFC). Prior to the GFC, shopping at ALDI might have been slightly frowned upon but shopping at ALDI can now mean you’re a frugal, savvy and switched on shopper.

The hard-discounters, retailers with a limited product range, low prices and a convenient shopping experience, are resonating with Australian consumers. Countries with high labour costs, store rent and retail margins are particularly ripe for discounter disruption and will continue to fuel their growth over coming years. Whilst ALDI is leading the charge of the hard-discounters, Costco is enjoying steady growth and Kaufland (another German retailer) will be joining the party in late 2019.

In the face of increasing food inflation and stretched household budgets, consumers are increasingly turning to ALDI and Costco, particularly low to middle-income shoppers. However, the draw of the hard discounters is more than just good value. Whilst consumers trust that these retailers are delivering the lowest price, they also appreciate the ease with which they can choose from a limited selection of offerings, which saves them time and reduces the mental effort of selecting from large product ranges. The predominantly private label ranges are good quality and competitively priced, and the everyday low price (EDLP) pricing strategy drives loyalty as consumers feel they get good value every shop. Discounters also run very few promotions in comparison to the majors and this improves shopability and again improves convenience.

Perhaps most worrying for Coles and Woolworths is that hard discounter market share in Australia is well below the global average and is likely to double over the next 5 to 7 years (from 9% currently to almost 20% by 2024). The reason for this rapid rise is most likely due to the majors progressively acquiring and closing established discounters since the early 90’s to maximise profits, such as Bi-Lo, Franklins and Food4Less, converting them to full line supermarkets and effectively eliminating the hard discounter format from the market.

This left a soft underbelly in the market and paved the way for the entry by ALDI in 2001; whilst the hard discounter format no longer existed in the market, consumer still wanted it and ALDI stepped in to satisfy that need. The fact that Australia was dominated by just two big retailers meant the profit-pool was large and ripe for the taking, and take is exactly what ALDI has done. This is most likely also the main motivator for Kaufland. In hindsight, Coles and Woolworths should have maintained their duopoly, but done so with clear high and low value formats (no different to the airlines with Qantas owning Jetstar, and Virgin owning Tiger – in terms of market structure this works, since the needs of all customer segments are met).

What’s the likely future state for Coles and Woolworths?

Counter-intuitively, the rise of the discounters has also been fuelled by the marketing behaviours of the majors. Coles relentless focus on price over the last eight years, starting with ‘Down-Down’ in mid-2010 and followed by ‘Deeper Down-Down’ in early 2014, has de-stigmatised ‘low price’ in the eyes of consumers. Woolworths was forced to follow Coles’ lead in lowering prices, and thus ironically, aided ALDI’s growth with their hugely successful value campaigns, Whilst Coles’ strategy based primarily on price has exacerbated the already commoditised nature of grocery retailing in Australia – as evidenced by the low loyalty and high cross-shopping by consumers, their focus on price may eventually come back to haunt them. Coles doesn’t have the scale advantage of Woolworths, with CODB estimated to be 1-1.5% higher, so it’s likely to be difficult for Coles to ultimately win the price war. Coles had over seven years of like-for-like sales growth higher than Woolworths, but this has now swung around; Woolworths has beaten Coles in the last five quarters, albeit growth is slowing.

With the imminent demerger of Coles from Wesfarmers and the arrival of a new MD, it’s likely that Coles will move away from price discounting to protect profits. Coles will have to differentiate on non-price attributes, such as service, fresh offering, range, in-store theatre and shop-ability. The question will be whether after the years of investment in lower prices, they have the margin fire-power available (down from 5.3% EBIT in 2016 and forecast to be 4.1% for FY18), particularly as volume growth has slowed.

For Woolworths, the relaunch of their loyalty scheme with Qantas, investment in more store hours to improve customer service and the refocusing on fresh foods, have created the green shoots of growth. With a forecast 4.8% EBIT for FY18, it’s almost half the margin they were making in 2015, so the amount of investment made shouldn’t be underestimated. As ALDI extends in SA and WA and matures down the east coast capturing more of the highly profitable ‘main-shop’, ALDI will capture further economies of scale and this will place further pressure on Coles and Woolworths – and it’s important to remember that Australia is ALDI’s most profitable market globally and could invest more in lower prices.

How do Coles and Woolworths compete with the hard discounters?

Coles and Woolworths have to compete on price, but do so rationally, and provide lower, stable pricing on the products that matter most to consumers. Based upon learning from overseas markets, this means ensuring Private Label ranges are within 5% of ALDI’s prices on their 1,500 core lines. At the same time, they must provide wider ranges in areas where discounters cannot compete, particularly in fresh foods.

Coles and Woolworths have already taken action, albeit there is an argument that more is needed since the gap isn’t closing. This includes removing needless choice (categories with too many product selections) and developing ‘optimum range’ by balancing product sales against product loyalty and providing a tailored range specific to the size and demographics of an individual store. Similarly, the majors must provide price certainty to customers by eliminating the promotion ‘high-low cycle’ and multi-buy discounts. Costco have been particularly successful in communicating everyday value to consumers on the premise of ‘bigger pack, better value’, and the majors have adjusted their offers accordingly, and also broadened the price architecture of categories to ensure each has a low entry price point product to compete head on with ALDI.

However, perhaps the elephant in the room is Private Label. Even after 40 years of Private Label in Australia, Coles and Woolworths are still struggling to develop Private Label strategies that can actually compete with ALDI without cannibalising their branded profit-pool. Until this is solved it will be hard to slow ALDI’s growth.

Read more on how Amazon will impact the Australian grocery market and what supermarket suppliers and producers can do to avoid becoming redundant.

Tristan at www.kitchenerpartners.com.au

Tristan is a specialist on the grocery retail sector and provides support to businesses along the whole value chain from retailers through to manufacturers, producers and growers. He has extensive retailing experience, having held management roles with Coles in Australia and Sainsbury’s in the UK. He is a regular speaker at industry conferences and appears as a sector expert in shows such as the Money Program on Sky News.
Sources: Morgan Stanley Research, UBS, Kantar, ABS, Roy Morgan, Euromonitor.
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The Retail Grocery War: Part 3

Wednesday, August 29, 2018

To avoid being caught in the intensifying retailer competition and inevitable focus on price, producers need to intimately understand their retail and end consumer, reduce costs whilst improving efficiencies, innovate and think differently.

The majority of fresh produce consumed in Australia is grown domestically, and prices are generally supply determined, rather than demand determined, which provides a level of protection. The inability of retailers to import fresh produce widely and the pro-Australian sourcing appetite of consumers, means retailers will be dependent on domestic supply and have to invest more resources to ensure they have a vendor base that is capable of meeting these needs. (Whilst out-of-season supply has good growth potential, they must be categories that are deemed acceptable by consumers, for example, out of season mangoes, citrus, stone fruit etc., and in line with FTAs).

For producers, it’s important to do the basics well, and make sure retail customers receive the right quality product in full and on time. There will be a greater need to ensure consistency in product quality, and this will be exacerbated by the increasing growth of the majors and need for greater volumes to meet demand. In addition, retailers’ growth will become increasingly dependent on the capabilities of their suppliers, with the more capable suppliers becoming increasingly more influential and gaining a louder voice.

In regard to technical expertise, specialist knowledge of fresh foods will become a core competency for success (understanding seasonality, varieties, cool-chain management, ripening technology, handling and merchandising displays etc). Retailers will increasingly directly employ industry experts and consultants in-house to provide specialist information, including technologists, agronomists and supply chain experts, so it’s important for producers to be appropriately skilled or risk becoming redundant. There’s also an opportunity in Australia, compared to say Europe or the UK, for technical improvement around food safety and quality assurance, and engaging with retailers on a technical level to tackle some of the tougher challenges, such as environmental degradation through declining soil health, water usage and improving consistency in product quality. The challenges around farm labour and use of hire companies are also a critical part.

In order to achieve a differentiated customer offering, retailers will focus upon Intellectual Property and exclusivity. Suppliers that can secure IP and exclusive access to better tasting varieties, and access to varieties with, for example, high ‘functionality’, such as longer shelf-life and higher vitamin content will in turn secure their future. As has happened internationally, retailers will look to make customer-centric claims and communicate their unique initiatives around provenance, sustainability, business ethics, organic and non-genetically modified etc.

Retailers are likely to embrace closed-system production that takes advantage of new technology to ensure year-round security of supply quantity and quality, such as greenhouses using LED lighting and elevated carbon dioxide to increase yields to lower long-term production cost. Similarly, high density orchards that are designed for mechanical or robotic harvesting will improve product uniformity with more fruit falling within supermarket specifications and reduce the dependency on seasonal labour. These innovations are capital intensive with long pay-back periods and are likely to drive further industry consolidation and corporatisation of farming.

The retail market in Australia is undergoing more change that it has in the last 40 years, and as the retailers are raising the bar for their consumers, so must growers and suppliers. It is important to challenge existing business models, look to innovate, and most importantly, ensure the right skillsets are in the business at the right time. Now is the time to take advantage of the changing retail landscape, as ultimately ‘change’ can also mean opportunity – and those that make the move first will be the ones reaping the benefits!

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Amazon wants you!

Tuesday, August 28, 2018

Grocery is hugely attractive to Amazon. Not only is it the largest retail category, grocery shopping is a high frequency and repeat purchase. In addition, unless you’re a retail analyst, grocery shopping is fairly dull, which makes it a good opportunity for using technology and smarts to reduce the consumer friction and pain-points.

Amazon is a retail juggernaut and will leverage its scale, deep pockets, long-term appetite and ability to fund bold R&D to add competitive pressure to the grocery sector. The key enablers for successful entry and growth in grocery retail is money, time and data, all of which Amazon has in spades. In 2017, Amazon spent $22.6 billion just on R&D, more than any other company in the USA, including Google, Apple and Microsoft. Amazon launched a checkout-free contactless store (Amazon Go) last year and is adept at using technology to improve the consumer experience. It is Amazon’s unrelenting customer obsession that is the single biggest threat to the incumbent grocery retailers.

Amazon’s non-food market share in Australia is forecast to be almost 5% by 2026, and 1.1% for food. Given the challenges around home delivery, sourcing and cool-chain maintenance with fresh foods, grocery food will be impacted first, however, perhaps the more relevant impact is the way that the imminent threat of Amazon is already changing the behaviours of the majors. The majors are getting ‘Amazon ready’ and learning from the impact experienced in other countries.

The majors will need to integrate physical and online shopping, along with digital and traditional shopping methods. This will require leveraging their existing assets, including bricks and mortar stores, loyalty programmes and customer data, and at the same time improving their offer in the areas that Amazon dominates, namely private label, click and collect models that are economically viable and the sweet spot of 1-hour delivery windows. Coles and Woolworths will increasingly need to understand their customers better to enable them to engage directly with shoppers and offer them unique services and experiences, and ultimately protect them from Amazon - Amazon is great at collecting all sorts of data and using it to offer things that people didn’t even think they needed.

This will all have to be done whilst increasing productivity to reinvest into lower retail prices and avoid the risk of operating deleveraging due to declining volumes; as a minimum it will require being competitive on the 20% of products that matter most to consumers (like the hard discounters). The end result will be further investment at a time when margins are already declining and ultimately ‘doing more for less’.

Amazon’s vocal supermarket killer…

Amazon has been a lead driver in the development of virtual assistants. These are voice-activated devices that let users ask questions or give commands to complete all manner of everyday tasks in more intuitive ways, including searching for information, organizing schedules and, of course, shopping – and do it 24/7, even when the majority of shops are closed!

Amazon’s voice-activated virtual assistant, the Echo speaker

Voice-activated virtual assistants, like Amazon’s Echo speaker, are now available for purchase in Australia (from $79) and will reach full functionality when used with Amazon Prime, which launched in Australia in June 2018 for an extremely competitive annual subscription fee of $59; (Amazon Prime is a bundled subscription offering, which includes movie and music downloads, photo storage, access to special deals and two-day delivery on purchases). This will truly help make grocery shopping a frictionless process: no more driving to a store, dealing with crowds or even sitting at a computer selecting products online, just simply talk to a virtual assistant and tell it what you want and when you want it delivered! Simple and convenient – and needless to say, voice-activated search algorithms will favour Amazon’s own products.

Essentially, grocery shopping today is more a physical selection of a range of regularly purchased items rather than ‘browsing’ in the traditional sense, so it’s well suited to voice-activated shopping. Virtual assistants are likely to reduce, or even eliminate, the need to regularly visit physical stores and the challenge for the major supermarkets is how they compete in this emerging digital marketplace; 25% of U.S. households already have a home assistant. By 2021, it’s estimated that 18% of total spending will be via virtual assistants (currently 3%). It’s no surprise that Walmart has partnered with Google as their technology partner to allow customers to link their store accounts to Google's Express shopping service and use voice-activated Google Home speakers to buy hundreds of thousands of items for home delivery.

Ultimately, the majors will increasingly need to defend customer traffic in physical stores, whilst also developing digital strategies that will compete with the convenience of voice-activated virtual assistants. However, the difficulty for the incumbent bricks-and-mortar retailers is that the digital disrupters have a different set of financial incentives; Amazon doesn’t actually need to make a profit from its grocery business. In the USA, 50% of consumers are Amazon Prime members representing 70% of consumer spend, so the key growth metric for Amazon is to increase spend per person within Amazon’s vast suite of products and services – in other words, getting consumers dependent upon the Amazon ecosystem, which in turn will make Amazon an even more attractive advertising platform for suppliers. It does suggest world domination with Amazon owning the customer as well as the suppliers and taking a slice of all revenue streams and doing so with no real desire for making a profit in the near-term. Scary.

If you would like more information, contact Tristan at www.kitchenerpartners.com.au
Sources: Morgan Stanley Research, UBS, Kantar, ABS, Roy Morgan, Euromonitor
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Australia's retail landscape in 5 years

Wednesday, May 18, 2016

By Tristan Kitchener 

With the grocery market in deflation, we are essentially already in a price war between the major supermarkets Woolworths and Coles. 

Take a look at the UK market, where the fundamentals are similar to Australia – the big four retailers in the UK are now four years into a price war, and their margins have dropped by 50% in that time.

The definition of a price war is “an irrational promotional intensity aimed at winning market share to counter the growth of rivals, where price investment is matched or exceeded by rivals, driving down industry profits at an accelerating rate”. Not my words, but it sums it up nicely, and it tends to be good for consumers, but bad for suppliers, retailers and of course shareholders as profits are squeezed.

Coles have been using the infamous ‘Double Loop’, where retail prices are lowered to increase volumes and the scale benefits are reinvested into further lowering prices, as per Roger Corbett’s strategy with Woolworths in the early 2000’s. However, the Double Loop is a strategy that works best for the largest incumbent (in regard to market share), i.e. Woolworths, or the aspiring new entrant who wants to grab market share (Aldi), but not usually the Number 2 - Coles. 

Essentially, Coles is cannibalising industry profits, and whilst they are the ones that started the price war, it will be Woolworths with their scale advantage that finishes it, with significant pain for both parties along the way. 

How far we fall into a price war is hard to say. But in the future state, post price war, in what you could perhaps describe as a disciplined, or more rational market, it could be a case of a divided market; Aldi taking ownership of value – that means good quality at a good price, Coles and Woolworths owning range and choice – with strong customer service and in-store theatre, whilst Independents own convenience. Fresh would most likely be shared with the majors and Independents.

Nevertheless, a common theme in any country that Aldi has entered is that the price gap between the majors gets materially closer, margins are squeezed and growth is lower. So for Woolworths, with FY15 margins at almost double the global average at 7.9%, they will have to get used to doing more for less with lower retail prices and lower margins, whilst also having to re-engage staff and re-engage consumers. The Holy Grail for Woolworths will be getting back to the position of ‘The Fresh Food People’ with consumers really believing and experiencing it.

Since Coles doesn’t have the scale advantage that Woolworths has, with CODB (cost of doing business) estimated to be 100-150bp higher, it’s likely to be difficult for Coles to ultimately win the price war, even though it has a more proven and experienced leadership team currently. It will have to differentiate on non-price attributes, such as service, fresh offering, range, in-store theatre and shopability.

For Aldi, it will be organic growth and continued expansion across Australia and selling more fresh foods - and of course, being prepared for the possible entry of another European hard-discounter, Lidl.

For Metcash and IGA, it’s about ensuring it delivers a unique customer proposition, differentiating itself from Coles and Woolworths, as well as resolving the structural imbalance between Metcash and IGA storeowners. Otherwise, there’s a danger that independent store owners will become internally focused as opposed to concentrating on encouraging consumers to shop at their stores. And the clock’s ticking. 

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