In August 2016, The Age published an article outlining yet another twist in Coles’ strategy.  The intention, this time, is to reduce the supermarket’s product range by 15%, to “drive the efficiency of the business to fund grocery price cuts and safeguard its market share.[1]

The notion of reducing the 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: 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 apparently needed 2-3 years to break even.

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 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 Shoeys, which it also later renamed to 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 it was still a minor player until Coles (and Woolworths) made another strategic blunder which cleared the path for Aldi to blossom – they progressively eliminated branded merchandise to the point where home brands constituted over 30% of their product offering.

You don’t need a science degree to figure out what this means long-term. As covered in an earlier article (Independent Supermarkets: Another Nail in the Coffin), if you mostly sell your home brand (like Aldi), your prices are 20-30% higher, and your EBIT is 25% lower, you have little hope to succeed.

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 Costco to grab a substantial market share. They gladly obliged.

Things can only get worse from here. By moving downmarket, Coles (and Woolworths) have now created an opening in the higher end of the market. David Jones are already contemplating entry into the supermarket business.  I would expect their offer to be more upmarket, with the kind of merchandise choice Europeans enjoy in their supermarkets.

As a result, I anticipate that 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 I’m afraid that its corporate inertia will 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% 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, I expect that Coles will 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 rename Coles to BI-LO. Some of the old signage may still be laying around.

[1] http://www.theage.com.au/business/retail/wesfarmers-to-cut-product-range-to-drive-efficiency-at-coles-20160824-gr08z3.html

This article was first published by Inside Retail, Australia’s leading retail trade publication.

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Andrew Gorecki, MD of Retail Directions, has worked with the retail industry since 1985. Industry insiders appreciate his strategic advice and insights, as he lives and breathes for the industry. Andrew received a nomination for the Australian Entrepreneur of the Year Award in 2010.
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