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CASE STUDY*

INTRODUCTION
When the Australian conglomerate Wesfarmers Ltd decided to demerge its Coles
supermarkets division in 2018, investors may have wondered why now? After all,
Coles was a huge cash flow generator which is exactly what conglomerate
companies need to manage their portfolio of investments.
But they also need profit growth and the Coles Group Ltd latest financial results - its
first as an independent entity - suggests that this growth may be hard to achieve.
The new CEO, Steven Cain, has identified a number of challenges: costs are rising
faster than sales; profit margins are smaller for online sales compared to traditional
bricks and mortar sales; and the fact that the company’s systems are just not good
enough, particularly within its supply chain (Coles 2019 p30).
Other more general issues Cain highlighted concern changing customer
expectations towards convenience, and, competitive pressures from international
rivals. This is not to mention the macroeconomic headwinds both within the
Australian domestic economy and potential slowdowns in the country’s trading
partners.
As Coles is one of the biggest companies in Australia with over 112,000 employees
(Wesfarmers 2018 p42), it also has a high profile when it comes to corporate social
responsibility. Its human relation policies necessarily impact a large number of
people. Its supplier relationship policies will have profound impacts on its vast supply
chain. And, because most Australians will shop at Coles at some point in time, the
company’s decisions about how it treats its customers and stakeholders more
generally, will impact its broader reputation. One only has to look at the nation’s
media to know that readers are vitally interested in the behaviour of such a big,
Australian company.
So, within the context of these pressures, Coles will need to chart a course to not
only satisfy its various stakeholders, but also an investor base that is naturally
interested in profit growth.

* By Craig Terry, March, 2019. Faculty of Business and Economics, Macquarie University. This case study has
been written for the purposes of discussion within the unit FOBE800 Contemporary Business Issues and is not
meant as an example of good or bad practice.

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Profit growth is something that Cain highlighted in the results presentation to
investors and analysts – not that the future looks bright; but that it in fact represents
a major challenge (see Figure 1).Coles had years of profit growth, representing a
turnaround from when Wesfarmers took Coles over in 2008, but this has changed
over the last couple of years due to the identified company specific and industry
wide pressures. Cain believes that this will require a strategic reset.

Figure 1 Coles Historical Earnings Before Interest and Tax (EBIT) and Sales growth

Source: Coles 2019 p31

While the demerger from the Wesfarmers parent was at a challenging time, and
even though the company will retain a 15% interest in Coles, the fact that Coles is
now an independent, publicly listed corporate entity for the first time in over a
decade, means that it can also develop a truly independent strategy, one that is free
from parent interference.
This is Coles’ and Cain’s challenge.

COLES: PAST AND PRESENT


Coles has a new board and leadership team but it is anything but a start-up
operation. The company has been operating for over 100 years. Sure, there are
challenges but on most measures of performance, Coles has achieved sustainable
successful for most of its proud history.
Its culture and place within the Australian retail environment represent a strong
foundation for any new leadership team.

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History*
George James Coles (G.J.Coles) was the eldest of several sons of George Coles
Snr, himself a retailer. After an overseas trip where he visited some of the great retail
stores in the USA, George Jnr was convinced that he could open his own variety
store instilling some of the values that he learned on the trip including what “ethics”
to employ. He wrote at the time that “a proprietor has to have a happy home life; he
has to have a contented staff; he has to have a store that he would be proud of; he
has to earn the respect of his fellow men; and to do all this, he must operate a
business that would be successful” (Barber 2013 p8).

Figure 2 G.J Coles in 1928


Source: Barber 2013 p25

The first Coles store was opened in Collingwood, Victoria in


1914. It was a variety store selling general merchandise
including clothing and fabrics and general homewares. The
format proved such a success that the company G.J Coles and
Coy was floated on the stock exchange in 1927.
George’s other brothers were also deeply involved in the
business. It was a close family and it was natural that they took
part in the running of the business over the coming decades. As they all grew up
together in their father’s family store it was possibly not surprising that one of the
brothers, Kenneth Frank, would remark in 1960 that all of the Coles brothers were
“bred behind the counter” (Barber 2019).

In addition to George, other Coles


brothers held both board and
management positions. The last brother
who held a leadership role was Norman
who retired as Chairman in 1979.

Figure 3 The Coles brothers in the 1970s,


clockwise from top left: Kenneth, Arthur, Norman,
Edgar and George.

Source: Barber 2013 p51

*Historical information is taken from Barber 2013 unless otherwise indicated

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George’s philosophy on retailing was quite simple: “Employees are instructed to not
press customers to buy….if an article is not sold in sufficient quantities to justify its
selling space on the counters it is dropped. A buyer takes the blame for purchasing a
line that does not sell, as we consider that if the public do not buy when shown, it is
not our duty to force it on them because we have made a bad purchase….When an
article is selling well, all managers are immediately advised to give increased
displays of it and order larger quantities .. as sales of a line fall off, its selling display
is correspondingly reduced. The customers themselves really decide what goods we
shall stock in our stores, as no article is added to our standard list till the public begin
to buy it freely. (Barber, 2013 p24)
It was not until the 1950s that Coles became the type of company that we would
recognise today. It made an acquisition of grocer Penneys in 1956 which provided
the company with its first large-scale experience of food retailing. Coles then
introduced self-service in 1958 and opened its first grocery supermarket in 1960 in
Balwyn, Victoria whilst retaining the Variety store format in its existing stores.

Figure 4 Coles New World Supermarket, Eastwood, NSW in 1963


Source Barber 2013 p64

The “Variety” store brand name would be later gradually phased out when Coles’
alliance with the Kmart group of America started to expand within Australia. The
Coles and Kmart relationship started in 1969 (Barber 2013 pp78). Kmart stores
would often be opened alongside a Coles supermarket (an arrangement we still see
today even though this relationship formally ended when Coles was demerged from
Wesfarmers in 2018).
Coles then merged with Myer department stores in 1985 but ended this arrangement
in 2006 when the two entities returned to being separate entities. Subsequently,
Wesfarmers took over the Coles company including its various brands (Kmart,
Target, Officeworks, Liquorland) in 2007.
The full timeline of Coles history, prior to the demerger in 2018, can be seen in
Figure 5.

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Figure 5 Historical Timeline of Coles Group

Source: Wesfarmers 2018 p26

Now, Coles is a standalone company once again. After a decade within the structure
of the Wesfarmers parent, the business is again free to fully pursue its own strategy.
Wesfarmers management would say that it has always been able to do this. But
organisationally, separation is now complete.
This comes with both opportunities and challenges.

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Succession
The new leadership group have indeed a proud tradition to work with. For CEO
Steven Cain, it is, in fact, the second time he has worked for the company. He
previously had responsibility for Coles in 2003 and 2004 before he was abruptly
shown the door by the then Coles Myer CEO Brian Fletcher (Greenblat 2018).
He earned the nickname of “Mr Ruthless” by making a number of structural changes
that were opposed by much of the then senior management group. He lost out back
then so, no doubt, he will relish this second opportunity.
Of course, Wesfarmers were well familiar with this when they appointed him as the
new CEO of the demerged Coles. In fact, Wesfarmers CEO Rob Scott said at the
time of appointment that Cain always had the right strategy at Coles Myer back then
but did not have the support of his superiors. "He was a change agent and
essentially the organisation rejected the change," and further, "[a]nyone that's trying
to drive a change agenda will be criticised." (quoted in Patrick 2018)
His prior retail experience includes time at British retail group Asda where he learned
his craft from retail guru Archie Norman. Norman says of his staff back then at Asda
that "[we] hired very smart people at a young age. We weren't in a position to hire
established executives. We didn't have the fire power. We were shipwrecked. We put
them through fire and they had a very steep learning curve."(quoted in Kruger 2018).
Immediately prior to his appointment as Coles CEO in 2018 he was head of one of
Coles rivals Metcash (see later). So, his knowledge of retail, and the Australian
supermarket scene, is unquestioned.

See an interview with Cain at the time of the proposed Coles demerger in 2018 here:
https://www.youtube.com/watch?v=4fS8-D0Pnz8

Coles Management Structure

Cain has been able to create a diverse team around him to take Coles through its
next phase of growth (see Figure 6). It is a combination of existing talent from the
Coles business as well as some new recruits.

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Figure 6 The Coles Senior Management Team

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Source: Wesfarmers 2018 39-40

Two recent new recruits include a Chief Marketing


Officer and Chief People Officer (left).

Source: Coles 2019 p5

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The Board

At the board level, there are 8 directors, seven of whom are independent. The
chairman, James Graham, has been a longstanding director of Wesfarmers (he has
resigned this position), and, through his part owned company Gresham Partners, an
advisor to Wesfarmers over many years.
David Cheesewright, one of the independent directors, will be Wesfarmers’ nominee
director on the board, Wesfarmers having this right due to its 15% shareholding (see
Knight 2018).
The 8 board directors are shown below:

Figure 7 Coles Group board of directors

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Source: Wesfarmers 2018 pp37-38

For more information concerning the charter of the board, which details its roles and
responsibilities, see here:
https://www.colesgroup.com.au/FormBuilder/_Resource/_module/ir5sKeTxxEOndzd
h00hWJw/file/Board_Charter.pdf

Coles’ Brands
Coles business is split between three major divisions:
- Coles Supermarkets
- Coles Liquor (Liquorland, Vintage Cellars, and, First Choice)
- Convenience

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Figure 8 Coles Group divisions

Source: Wesfarmers 2018 p28

Coles Supermarkets, the biggest division within the group, runs the following stores:
Figure 9 Coles Supermarket Stores as at 30 June 2018

Source: Wesfarmers 2018 p31

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Also within the division, is the developing online business. Customers can order
online and receive delivery of their grocery shop. A “click and collect” service is also
offered.
Coles also offers financial services via insurance, credit card and loan products.
Coles has relationships with IAG as backers of the insurance policies, Mastercard for
the credit card products and with Citigroup for the loan products. See the Coles
Financial Services website here:
https://financialservices.coles.com.au/
Coles Liquor division has 899 liquor stores as at 30 June 2018 around the country.
(Wesfarmers 2018 p32). The brands operated by Coles Liquor are:
- Liquorland;
- Vintage Cellars;
- First Choice Liquor;
- First Choice Liquor Market;
The First Choice Liquor Market brand is a relatively new initiative with 15 so called
“big box”, low-cost, warehouse style stores converted to the new brand in FY19. How
this develops alongside the existing First Choice brand will be keenly followed by
market observers in the coming periods.

Figure 10 A First Choice Liquor Market store

Source: Coles 2019 p22

Coles Liquor also operates 87 hotels under the Spirit hotels brand. The reason for
this is that in the state of Queensland, retailers must own a hotel license to obtain the
right to then open liquor stores. It was recently announced that Coles would enter

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into a joint venture whereby it would retain operation of the liquor stores whilst
allowing AVC Ltd, the joint venture partner, to operate the hotels (see Coles 2019b)
Coles also has a Convenience division which operates the Coles Express brand.
These are smaller supermarkets located in high volume, often city based, locations,
or, attached to service stations. Coles has recently re-negotiated an agreement with
Viva Energy (the owner of the Shell retail brand) to continue locating Coles Express
stores within Shell outlets. As of 2018, Viva operated 1000 Shell outlets around
Australia of which Coles Express operated in around 700 (Latimer 2018)
The other operating division is the so-called Fly Buys operation. Its members earn
points which are redeemable at participating organisations. It is a loyalty program
with over 8 million active members and 6 million households (67% of all Australian
households) (see Wesfarmers 2018 p34).
With that many members it was no surprise that Wesfarmers was keen to retain a
substantial interest in this operation when Coles was demerged - Wesfarmers only
retained 15% of Coles but decided to retain 50% of this loyalty company. No doubt,
like other retailers around the world, Wesfarmers can see major data mining
potential from this entity in the future.

Financial Performance
Coles’ latest half year results, released on 19 February, 2019 are shown below:
Figure 11

Source: Coles 2019 p8

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The financial results for Coles for the past 5 full years (when it was part of
Wesfarmers) are shown in Figure 12
Figure 12 Revenue, EBIT and some key financial indicators for Coles 2014 to 2018

Source; Wesfarmers 2018b

More detail concerning the performance of Coles’ three divisions can be found here:
https://www.colesgroup.com.au/home/?page=home

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Going forward, what are Coles’ major strategies? Steven Cain identified 6 major
planks in the latest result presentation (Coles 2019 p16):
- Transform the food offer including convenience and own-brands;
- Reviewing pricing methods;
- Continued improvement in the online offer;
- Continued store investment;
- Reduce costs;
- Work with stakeholder groups.
Some of the issues underlying these strategies will be discussed later but time will
tell if Cain’s strategies prove to be successful. Strategies need to be created and
implemented within not only the company itself, but also an industry, and
macroeconomic environment, which in Australia and internationally has been
unforgiving to poorly management companies.

THE RETAIL INDUSTRY


Although Coles has diversified its business base into areas like financial services,
Coles has always been a retailer. This is not necessarily a bad thing. From a Return
on Equity (ROE) perspective, the retail industry is a good performer. Figure 13
shows that return on shareholders’ funds in retail, on average, are higher than most
other sectors.
Figure 13 Return on Shareholders Funds

Source: Productivity Commission 2011 p44

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There are a number of sub-sectors within the industry as defined (ANZSIC Division
G – Retail Trade):
- Food
- Household Goods
- Clothing and soft goods
- Department Stores
- Other retailing

The shares of each are shown below:


Figure 14 Retail Trade Turnover by Sector

Source: Productivity Commission 2014 p39

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An indication of the breakup of products in the food and grocery industry is shown
below:
Figure 15 Australian Supermarket and Grocery industry

Source: Mudditt, J. 2017

Many of these items are seen as non-discretionary. This means that in times of
recession, sales within these categories would be reasonably maintained. It is the
discretionary, more luxury type items that may be more susceptible to sales impacts.
In Coles’ key competitor Woolworths Ltd latest result presentation, CEO Banducci
warned of possible side effects if economic momentum turns down. “Dan Murphy's
[liquor store] is our business that is most leveraged to discretionary spend... for those
customers, what they’re wanting is an affordable basket of goods….We saw material
trading down from champagne to sparkling wine, for example, which flowed through
the results. That goes to a feeling of affluence." (quoted in Hatch et al 2019)
The main worries in the Australian economy presently are low growth rates of
household incomes with, concurrently, the high growth of household debt along with
falling house prices. These major economic variables are shown in the following
figures from the Reserve Bank of Australia.

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Figure 16 Housing Prices and Debt

Source RBA 2019

Figure 17 Household Income and


Consumption

Source RBA 2019

The rise in the levels of household debt has, at least in part, contributed to the
historically high levels of property prices. But as we are now seeing, prices are
dropping. While low interest rates help, high debt requires servicing.
Some observers see a significant “wealth effect” from property prices for
homeowners. The former CEO of Woolworths, Grant O’Brien certainly thought so:
“People talking about the value of their homes is part of how people get confidence”
(quoted in Mitchell 2015a).

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O’Brien was talking in 2015 about the wealth effect when house prices were going
up. Talking about conditions now, Mark Steinart, CEO of Stockland Group, an owner
of shopping centres, thinks that the recent fall in house prices has a negative wealth
effect as well. “Negative house price growth in Sydney and Melbourne affects the
consumer, that’s one of the things hitting consumer sentiment right now” (quoted in
Hatch et al 2019).
How much of a negative wealth effect there will be is probably a bit of worry for
retailers. It may be fine. If interest rates stay low, employment remains high and/or
house prices stay up and don’t deflate within a dramatic, “bubble”-type scenario,
things may turn out okay for retailers.
But generally, companies have found it hard to achieve sales growth since the GFC.
While Australia avoided recession, economic growth has been moderate at best.
Companies have had to cut costs as opposed to ride sales growth to achieve
moderate levels of profit. This has contributed to the low rate of wages growth as
shown in Figure 17.
In the absence of any major expansionary fiscal or monetary policies (over and
above anything currently in place), companies may find it difficult to find profits as the
economy continues to feel the effect of low international growth and a fading
Australian resources investment boom.

The competitive Landscape


Of all the retail sectors, there are few that have a higher profile than supermarkets.
These are the retail stores that provide most of our daily or weekly basic needs.
When consumers start thinking about their incomes and “cost of living” pressures,
the prices that they have to pay at supermarket checkouts are usually the first place
where complaints potentially surface.
The Australian supermarket industry has been particularly susceptible to these
complaints due to its highly concentrated structure. Two major chains dominate –
Coles and Woolworths. However, the dynamics of the industry appear to be shifting
with the entrants of smaller, overseas players.
The main players apart from Coles in the Australia are:
- Woolworths
- Aldi
- Metcash (through the IGA brand).
Other new and potential entrants include the US giant Costco, and, European
chains, Kaufland and Lidl (more on this later)

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Market share information as at 2018 is shown below:

Figure 18 Australian Supermarket Market Shares as at beginning of 2018

Source: Wesfarmers 2018 p29

Woolworths
Woolworths is Coles’ largest competitor. In addition to supermarkets, Woolworths
owns liquor stores (BWS, Dan Murphy), and Big W, a discount department store (this
brand is a direct competitor of Wesfarmers’ Kmart and Target).
Prior to Wesfarmers takeover of Coles in 2008, Woolworths was seen by analysts
and investors as the more successful of the two. In 1999 it implemented a business
model called Project Refresh. This was focused on stripping costs from the supply
chain and putting a large part of these savings into reduced prices. These reduced
prices would then push up sales volumes improving profit. This “productivity loop”
was well known in the retail world but the then CEO Roger Corbett executed the
strategy impeccably (Bartholomeusz 2009)
Fast forward and the dangers of not passing at least some cost savings through to
customers was shown by the replaced CEO of Woolworths, Grant O’Brien. He
flagged in 2015 lower than expected profit growth and Woolworths’ share price was
punished accordingly. The major criticism had been that the company had fattened
its gross margins at the expense of sales.

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The following graph clearly showed this trend:

Figure 19 Woolworths Gross Profit Margins 2008 to 2015

Source: Mitchell (2015b)

In a 2015 strategy briefing to analysts, O’Brien admitted that Woolworths had lost
sight of its customers. This was seen by some analysts as an acknowledgement that
prices needed to be reduced (indeed, recognising this, $500m had been committed
for that purpose).
“If we address customers successfully” Obrien stated at the time, “sales momentum
comes. If sales momentum comes, margin comes. Margin is an outcome” (quoted in
Heffernan 2015a).
As if to emphasise this, CEO Grant O’Brien, as we have now seen, was moved aside
and Brad Banducci, is now running the business. Banducci has re-established a
retail fundamental – satisfied customers.
But this may not all be about lowest prices. His strategy for the group was outlined in
Woolworths latest half year results presentation - see Figure 20.

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Figure 20 Woolworths’ Strategy

Source: Woolworths 2019 p5

Historical 5-year financial data for Woolworths can be found here:


https://www.woolworthsgroup.com.au/content/Document/Woolworths%20Group%20
2018%20Full-Year%20-%20Five%20Year%20Summary%20PDF.pdf

Aldi
A major cause of this recent orientation to price is the growing pressure from the
German group Aldi who entered the Australian market in 2001. It is originally from
Germany with operations in Europe and the United States. Aldi targets the lower end
of the market, and, bulk buyers. Its market share is small but growing (see Figure
18).
This growth has been helped by a loosening of restrictive lease agreements between
major retail chains and shopping centres which was a result of a major government
enquiry into supermarket competition in 2008 (see ACCC 2008).

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Now, Aldi is seen as a third option for the managers of shopping centres. Scott
Dundas, of Charter Hall Retail REIT, an operator of shopping centres says that “we
see the expanded offerings of three supermarkets as an opportunity to drive real
value. Aldi satisfies a niche in our customer base and we will talk to them about
rolling out more, where possible” (quoted in Heffernan 2015b)
Its physical stores are quite different to the full-service offerings of Coles and
Woolworths. They generally have a significantly smaller range, limited customer
service and an absence of prepared or pre-prepared meals. In its submission to a
Federal parliamentary enquiry into tax, Aldi defined what it believes are its key
features (Aldi, 2015). These include, the company says:
• A limited range of high-quality private label products (Aldi says it stocks an
average of 1,350 lines of grocery products compared to 15,000 to 25,000 for a
full-service supermarket);
• Long term, consistent relationships with suppliers;
• A simple and efficient store layout and design;
• A smaller store format;
• Multi skilled store staff; and,
• Cost savings in no free plastic bags, customer self-packing and coin trolley
return.
A significant point of difference of Aldi to the major supermarkets all over the world is
its use of private label products. All supermarkets have private labels, but Aldi’s
range is extensive. Over 95% of Aldi’s products are private or controlled labels
compared to around 20% in Coles and Woolworths (Heffernan 2014). And, the
profile of the Aldi customer seems to like this: over 60% of Aldi customers prefer
private labels compared to only 30% of shoppers at Coles and Woolworths (Han
2015).
There are a number of benefits of private labels to retailers. Clearly, if customers
want to buy products that only you stock, you’ve cornered the market! But, one
British expert, Edward Garner, who has experienced the Aldi impact in the UK
market makes the warning to the majors when thinking about their own private label
strategy: “Just sticking a name on a product is not a brand”, he says, “a brand has
got a heritage and a back story” (quoted in Mitchell 2015c)
On top of the private label positioning of the group, Aldi sees itself as a price leader.
And this has definitely been the experience in Europe and the UK. Market leaders in
the UK like Tesco and Sainsburys have lost market share to the discounters, Aldi,
and another discounter Lidl – also a German supermarket company. Figure 21
clearly shows the impact of the discounters in the UK market over 2017/8.

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Figure 21 UK Market Shares

Source: Jahshan, E. 2018

The major players have responded to this threat over the past years in the only way
they feel is right – by lowering prices. What is most worrying however for the CEOs
of all the majors in the UK is that Aldi management has “vowed to do whatever it
takes to be cheaper than its rivals and claimed the big chains would never be able to
match its prices” (quoted in Farrell 2014). Worrying indeed for Australian
supermarket chains.
Independents supplied by Metcash
Aldi’s success in Australia has particularly come at the expense of what was seen,
up until quite recently, as the “third force” in Australian supermarkets, Metcash,
which operates under the IGA banner. Market share data in Figure 18 tends to
support this. It’s had some rocky times (see Mitchell 2015d).
With a turnover of $14 billion, it is a wholesaler and distributor of groceries to the IGA
chain of independent supermarket owners. It is a “banner group” arrangement in
respect to buying and promotion. The individual IGA operators retain ownership but
get the benefits of belonging to a large buying group.
Metcash distributes through its warehouses to over 2000 IGA stores nationally (see
https://www.metcash.com/about-us/

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Costco
In a relatively recent development, Costco, the giant US retailer, opened its first store
late in 2009. Costco operates on a membership basis where customers pay an
annual fee to shop at the store and gain access to discounted items. Items sold
include, groceries, homewares and other non-food products. Other retailers will need
to take note even if competition appears to be more localised at this point of time.
More Overseas Competition?
And, in a very recent move, the European chain, Kaufland, has announced it will be
entering the Australian market place. Kaufland operates “hypermarkets” which are a
mix of supermarket and discount department store (like Kmart) formats. Kaufland’s
managing director in Australia, Julia Kern, described them as a “one-stop-shop”
(quoted in Johanson 2019). It will take years before Kaufland may make a material
impact to Coles’ market share, but it is something it will be closely monitoring.
Of course, the other ominous threat is from the internet.
Online retailing
The high Australian currency experienced during the mining boom certainly helped
this. Even though this effect has to some extent now dissipated – the $A has
depreciated significantly against the $US – consumers have become seemingly
more comfortable about making on-line national and international purchases.
The proportion of total online retail sales is relatively low compared to international
figures. One government inquiry identified Australia as being a “laggard” in online
sales – Figure 22 (Productivity Commission 2014)
Figure 22 Australia’s relative performance in online retailing

Source: Productivity Commission 2014 p23

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In respect to Coles’ recent performance, one could argue that there are some
promising signs:

Figure 23 Coles Online sales growth

Source: Coles 2019 p17

But in spite of Coles and other Australian businesses starting to catch up, a recent
comparison of online shopping internationally still puts Australia in a relatively low
spot – see Figure 24..

Figure 24 International comparison of online retail sales

Source: Kovacs, A. 2017

And, the operator that all retailers are worried about is Amazon. The company’s
share of eCommerce generally, in each country, is shown in Figure 25.

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Figure 25 Amazon share of eCommerce retail sales in each country

Source: Kovacs, A. 2017

When this is compared with the share, and growth of this share, that Amazon has in
the US online retail market, some alarm bells may start ringing in the ears of the big
Australian retailers – see Figure 26.

Figure 26 Amazon US Share Online Retail

Source: Kovacs, A. 2017

Amazon has also shown an interest in bricks and mortar food retailing by taking over
the Wholefoods chain in the US (see Rigby 2017). The company made its intentions
clear that it wants to operate across all retail channels.
But it’s not just the big online competitors. Niche players are also posing a threat.
Companies like HelloFresh, Kogan Pantry, GroceryRun, My Food Bag and Lite n

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Easy are all offering a food offering either as a “shopping service”, prepared meals,
menu design or other variation in this space.
All small. All niche players. All offering something that customers value it seems over
and above what they are currently getting from the major chains.
The rise of Uber Eats is also addressing a whole new space. Is the more affluent
type of customers moving to these offers and away from traditional food shopping?

THE CUSTOMER
What then does the customer value? In the online world, a relatively early survey of
online shopping conducted by the Australia Institute in 2011 discovered a number of
value drivers. This is shown in Figure 27.

Figure 27 Online customer value drivers

Source: Hartge-Hazelman 2011

However, it’s not all easy for online shoppers. A recent survey identified a number of
frustrations (Canstarblue 2019). These were:
- Delivery Costs;
- Not getting the products you ordered;
- Freshness of food Delivery timing;
- Lack of special offers/promotions online;
- Tendency to spend more online;
- Difficult to use websites.

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In the bricks and mortar world, there also seems to be a number of value drivers:
Figure 28 Most (and least) important factors for Australian grocery-buyers choosing a supermarket

Source: Roy Morgan 2015

The major chains clearly have a view on this. Woolworths included the following
summary in their 2015 Strategy Briefing:
Figure 29 Customer Shopping Criteria

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Source: Woolworths (2015)

The company also splits up customers into particular segments:

Figure 30

Source: Woolworths (2015)

The segmentation of customers implies that some customers may value some things
over others. This of course is the essence of executing the retail business model:
procuring goods that customers want and are prepared to pay for. All retailers are
committing major resources in trying to understand who its customers are and what
makes them tick.
Woolworths, for example, took a half share in data analysis firm Quantium in 2013.
This collaboration will help the company generate new insights into their customers.
As shown from Woolworths 2015 strategy briefing day presentation (Figure 31),
through the combination of the data that comes from their checkouts and other
sources with state-of-the-art software and rigorous analysis, the “data mining” and
analysis of customer behaviour has become prominent.
This will only become more prevalent as technology develops and consumer
shopping behaviours become even more visible.

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Figure 31 Woolworths Data Management Model

Source: Woolworths (2015)

And, as has already been discussed, Coles in partnership with its former parent,
Wesfarmers is maintaining its own capabilities in this area through the operation of
the FlyBuy loyalty division.
But, while data mining helps retailers understand and to segment customer, if you
listen to the financial analysts and investors, it may still appear that “price” remains
the most critical factor. Looking at some recent marketing material of the three
largest chains, while the concept of “fresh” is clearly an important attribute that any
grocery retailer would need to demonstrate to potential customers, price promotion
still seems to dominate:

Figures 32 and 33 (Coles promotional material)

Coles’ long running and seemingly highly successful “Down


Down” campaign

Page | 32
Coles catalogue of February 13, 2019

Figures 39 and 40 (Woolworths promotional material)

The “Cheap, Cheap” campaign

Woolworths catalogue of February 13, 2019.


Price is still important it seems!

Page | 33
All chains are pursuing aggressive pricing strategies. This may be due to the impact
of Aldi’s presence (this seems to be the case in the UK), or it may be customer
driven since the GFC – customers may be more keenly price conscious now. It may
be a combination of the two or, indeed, due to other reasons.
Coles take pricing very seriously. Management work at it continuously to maintain
price competitiveness: they compare prices of 8000 items every week and these
items account for about 70% of sales volume (Maiden 2015).
But even within the overall strategy of price competition there are still further choices.
How exactly should prices be set? There are choices about whether you are going to
be a price leader or simply match your competitors pricing. But what about
promotions? Or whether you want to promote short term price positions or have
more of a consistent approach to pricing items.
Currently there is a debate between analysts and the majors about these questions.
Some believe that “everyday low pricing” where you set a price and hold it there
builds customer trust concerning your value proposition: customers know every time
they enter your store, they can trust that they will get low prices.
Others believe a “high/low” pricing strategy, where products are constantly moved in
and out of price promotion periods is better as it takes advantage of “impulse” buys
and potentially gets customers, particularly new customers, into your stores chasing
these promotions.
Coles and its new CEO Steven Cain has a view on this. In Coles’ latest results
presentation, it appears that they wish to move to “everyday low pricing” (see Coles
2019 p16)

SUPPLIERS
Of course, pricing very often relies on promotion and promotional activity is
commonly planned jointly with suppliers. It is often the case that suppliers will make
financial contributions to the retailers to cover the costs of advertising and the
printing of promotional materials. “Contributions” may also amount to reductions in
the costs of the goods themselves and/or joint cost reduction negotiations in supply
chain processes.
These negotiations can get tough indeed. In fact, in December, 2014 Coles agreed
to settle an “unconscionable conduct” court action brought about by the ACCC on
behalf of suppliers who believed they were unfairly treated. In addition to fines, the
company agreed to open up a review, to be conducted by an independent party, for
a full 220 suppliers if the suppliers believed that they were treated improperly during
contract negotiations (ACCC 2014).
More generally, over the longer term, industry participants and analysts argue that
the burdens of cost “sharing” have unfairly fallen on suppliers. It’s argued that there
has been a significant shift of profit shares away from suppliers to the big retailers.
According to a report produced by the financial services firm, UBS and the Australian

Page | 34
Food and Grocery Council (AFGC), retailers have been actually overearning by
taking margin from suppliers. In a survey of 66 food and grocery suppliers that
represent 40% of the industry, it is calculated that 250 basis points of profit margin
had been shifted from suppliers to retailers over the last five years (reported in
Mitchell 2015e). Also, the Australian Competition and Consumer Commission
(ACCC) chairman Rod Sims has agreed that a level of profit shifting has taken place
and says that high profit margins at the big retailers were largely a result of a cosy
duopoly over decades (cited in Evans 2015)
No doubt, retailers are tough negotiators. Many observers could cite the rise of the
supermarkets’ development of their own private labels as yet another area where
they are extending this power. The so-called “milk wars” could be seen as an
example of this. Coles reduced the cost of their own branded milk to $1 for 1 litre.
This was seen by many as an aggressive marketing campaign implemented at the
expense of dairy farmers.
Using a private label strategy is one that Aldi has so successfully undertaken.
Worrying stuff for suppliers. After all, supermarkets control what goes on their
shelves. So how can suppliers counteract this particular trend? Some would say,
make sure you have loyal customers who will only buy your product.
Jean-Yves Heude, a former chief executive of US food giant Kellogg’s says that
“[uniqueness] drives loyalty and if consumers are loyal to your brand the retailer
won’t touch you; loyal consumers will go to another store if they cannot find their
preferred product, then the retailer runs the risk of losing the entire basket” (quoted
in Mitchell, 2015f). Maybe, but it appears that this will be tough in the face of retailers
who are trying to create their own customer loyalty through the creation of their own
brands; look at Aldi!
While suppliers will always complain to some extent about aggressive negotiations
and tactics from their biggest and most important customers, it seems clear that the
historical dominance of the two big supermarkets has had an impact on the power
relationships within the industry. As well as economic outcomes, this has resulted in
some political action over recent years.
Agitation by stakeholder groups with the cooperation of the retailers themselves,
(including Coles’ former owner Wesfarmers which was a major driver) has resulted in
the development of an industry “code of conduct”. This is a legislated code but is
ultimately voluntary, that is, it will control those parties who choose to “opt-in”. It
covers a number of areas such as what should be in an agreement, how payments
should be made and what these should be for, quality standards, supply chain
processes, intellectual property and dispute resolution procedures. The aim of the
code is to promote transparency, good faith and trust (ACCC 2015)
The code provides a standardised set of principles that all parties can use to guide
practices within the industry. Coles application of these principles can be seen on
Coles supplier website:
https://www.supplierportal.coles.com.au/csp/wps/portal/web/SupplierRelations/Suppli
erCharterAndGroceryCode

Page | 35
Coles is also a member of Suppliers Ethical Data exchange (SEDEX) which helps to
ensure the ethical sourcing of product throughout its supply chain (see Wesfarmers
2018 p43).
In addition, the Australian parliament recently passed anti-slavery (i.e. anti-
exploitation) legislation requiring companies with annual revenues over A$100million
to report annually on the potential risks that there may be people working under such
conditions in their supply chains and how that may be mitigating those risks (See
Redmond 2018). This has increased the requirement for transparency in a
company’s entire, integrated supply chains. A challenge, but one that has been
brought about by powerful interest groups worldwide in recent years.
So, while the management of domestic and international suppliers on the
commercial grounds of price, quality, and efficiency are key, issues of “fairness”,
“ethics” and “doing the right thing” are now, therefore, also becoming more
prominent. How retailers tackle these issues both politically and on a day-to-day
operational basis is getting more exposure. As noted, and particularly for the large
players, these broader issues can, therefore, also be key ingredients in successful
longer-term outcomes.

THE CAPABILITIES OF RETAILERS


Conceptually, the retail business model is a relatively simple one: goods are bought
from suppliers and then on-sold to the retailer’s customers. Retailers therefore need
buy the right product at the right price, get it to the retailer’s selling locations, and,
motivate customers to buy the goods. Simple to state but somewhat more difficult to
execute.
A basic depiction of the retail model was presented at Coles’ strategy briefing day in
May, 2015 (Wesfarmers 2015). This is shown in Figure 42.
Figure 41 Coles Value Chain

Source: Wesfarmers 2015 p38

Page | 36
The existing Coles Supply Chain network has the following national coverage
Figure 42 Coles Supply Chain Network

Source: Wesfarmers 2018 p36

Each site represents substantial distribution centre facilities. These are vital in
getting food and groceries efficiently to stores and customers. Coles are, in fact,
committed to spending a further $950 million on these and other new facilities over
the next 6 years (Coles 2019 p4). Coles’ CEO Steven Cain sees cost reduction
potential in this expenditure as extensive costs are incurred throughout the retail
value chain.
Generally, activity costs can be broken down into the following two, broad
components:
- The cost of goods (COGS)
- The cost of doing business (CODB)
The COGS are the costs of procuring the goods from suppliers. These costs are
mostly negotiated by the retailer’s merchandisers (buyers).
The CODB includes labour costs, rent and other occupancy, and other period costs
associated with the marketing and overall administration of the retail business.
As a retailer, to improve profit margins on the cost side, goods can be purchased
from suppliers more cheaply, or, efficiencies can be made to reduce costs of
conducting the retail business. The cost components of the retail business model are
categorised in Figure 43.

Page | 37
Figure 43 The Breakdown of Retail Revenue

Source: Productivity Commission (2014 p58)

By way of comparison, the following figure shows relative shares of the CODB
categories across some well-known retailers in different retail sectors in 2014.
Figure 44 The relative shares of Cost of Doing Business across retailers

Source: Productivity Commission (2014 p62)

Page | 38
Across the value chain, a major cost of doing business is, of course, staff. Labour is
required to carry out the organisational functions involved in the various activities
required to deliver goods to customers successfully.
Retailers organise their structure in some manner that they see as appropriate (in
relation to their strategies) in order to carry these activities out. The structure would
include at least the following functions:

1. Merchandise – the decisions concerning what products to range, what


suppliers to use and the negotiation of contracts and prices.
2. Operations – the management of the store network: making sure stores are
running smoothly and properly staffed; ensuring stores are not out of stock;
providing the “face” to the customer.
3. Property Management – identifying store sites and negotiating rents and
tenancy contracts; stores typically lease sites but may also own them freehold
4. Marketing – providing strategic input to the position of the “brand” on a longer-
term basis, that is, the overall framework within merchandising decisions are
made; managing marketing activities including advertising
5. Logistics – making sure goods get to store efficiently and on time
6. Human Resources – providing specialist input into how to manage staff
resources in including recruitment and training
7. Finance and Administration – the accounting and administration of the
activities of the retailer
8. Information technology – providing expertise for IT applications such as Point
of Sale, and Merchandise and Logistics systems; overall management of
system environments.

Appropriate skills within each of these operational levels are critical. And, the
diversity of skills, knowledge and behaviours is also being increasingly recognised as
a prerequisite for the long-term success of any business. Just like its former parent
Wesfarmers, Coles has committed to reporting progress against its diversity policies
and objectives each year in its annual report. (Wesfarmers 2018 p56).

COLES: WHERE TO NOW?


The many stakeholders of big companies like Coles require a range of value
outcomes which will depend on these skills. One of CEO Cain’s 6 main strategic
planks is termed “Win Together” (Coles 2019 p18). It explicitly acknowledges the
need to improve team engagement skills and behaviours amongst its employees as
well as providing continuing support to suppliers and to the community with a specific
focus on food programs and the farming community
Cain also recognises that he must deal with the competitive challenges facing the
company. As we have seen, Amazon and Woolworths, as well as smaller niche
players are all competing in the same retail space. He says that “[it’s] time to reset

Page | 39
the Coles business to achieve sustainable long-term growth for our shareholders; a
strategic refresh to ensure we appropriately address the headwinds facing the
company” (quoted in Mitchell 2019 p19).
The challenges facing Coles represent both threats and opportunities. Will Cain’s
current strategies be enough? Will Coles diversify into other brands offering new
products and services to new customer segments? Will it move into completely
different areas? After all, Coles is selling financial products through its retail
distribution network. Why not something else? Complex competitive environments
may require complex strategies.
At the time of Norman Coles’ death in 1989, the last of the brothers to have a
leadership role in the company, G.J Coles and Coy was the eleventh largest retailing
network in the world. Norman, a modest man, described himself and his four
brothers as “just ordinary shopkeepers” (quoted in Barber 2019).
The philosophy worked for them but is this indeed a new retail world?

Page | 40
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