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.