Price wars over?

The Australian grocery retail landscape is set for big changes as Wesfarmers has announced it will sell 80% of Coles Supermarket to the public. According to the pre-IPO sales pitch from Wesfarmers, Coles will now transform itself by moving away from its long-running deep-discounting strategy and opting for a more profitable loyalty proposition backed with “stories”.

Wesfarmers is selling down its stake at a curious time as Coles has lost momentum in sales growth and has posted falling earnings. Coles now trails Woolworths in same store sales after leading for 6 years in this key indicator of underlying health.

The chief reason for a sale is that Coles makes an insufficient return on capital – as it still owns a large chunk of retail stores. Wesfarmers never really set out to improve the capital efficiency of its investment in grocery, by realising cash for bricks and mortar assets which has long been a key part of the Woolworths lean, high-returning model.

Wesfarmers bemoaned the fact that Coles has weighed on its overall performance in generating returns on capital employed (ROCE in finance-speak). Coles reaps just a 9% ROCE, Bunnings achieves 47%, while Woolworths food business pulls a stunning 200% – essentially running the business on the payment terms of suppliers.

But is a prompt transformation in Coles feasible? I grimaced through a recent article on the Conversation website would have us believe that this is an easy process of switching onto a new game plan and that everyone else will stand back and let you.

It is naïve to think so – it took several years to reposition Coles by improving the culture of its people and building trust in shoppers when it was languishing in 2008. Much of that trust – such as it is – was based on every day low prices – the “down-down” strategy. It now faces a resurgent and well-managed Woolworths supermarket group and an expanding Aldi, which is only part of the way through a store roll-out to steal share of the cheap parts of the weekly shopping list. Aldi continues to drive the private label agendas of all the chains.

Then there is Amazon, which plans an aggressive expansion to redefine online grocery shopping. Local retailers have been playing with online grocery for years – without much success.

Loyalty programs in use are weak, offer little reward for return business are poorly understood.

Down-down might disappear soon, but don’t expect to see any less intensity in price discounting for the weaker of the two major grocery chains to recover sales growth and earn better margins.