Task Overview: WesFarmers –CASE STUDY*

Task Overview:

 

Part A – Application of the Strategic Management Cycle Framework

 

Part B – Application of “Specialist” knowledge to a chosen issue

 

This project uses a major Australian organisation as a case study (materials supplied).

 

Part A

 

You will take on the role of “strategic consultant” and apply the general strategic framework explored in this unit to the organisation to develop a strategic business plan.

 

Marking criteria:

 

The professional production of the report, its logical development of ideas, sentence skills, structure of text, and awareness of the target audience

The clear and thorough referencing of the sources all facts, views and opinions quoted or summarised that are not your own.

The relevance of the information and resourced materials used (both quantitative and qualitative).

The relevant and appropriate application of strategic analysis tools (that is, tools and techniques should be applied that are relevant to the analysis being undertaken).

The quality and validity of recommendations and defence, and how well these are based on the strategic analysis (that is, the reader should clearly understand why you are making these recommendations given the previous discussion within your analysis)

How practical the recommendations are to implement within the context of the organisation (this should be demonstrated within your discussion of how these are to be implemented)

 

 

Additional information/preparation:

 

Key activities/elements include:

 

Identifying the major issues confronting the organisation based on the case study materials.

Undertaking further research to obtain more detailed background information

Applying the strategic management concepts and analytical tools discussed within this unit appropriately to fully define and explore these issues.

Performing more detailed analysis as appropriate and relevant to help frame and provide context for the recommendations.

Using the outcomes of your analysis to make clear, logical and implementable recommendations to help manage and/or benefit from these issues.

Producing a report that is detailed enough to enable the organisation to commence planning/implementing your recommendations.

 

 

Part B

 

You will take the role of a “specialist” utilising the knowledge you have acquired within your Masters’ program to demonstrate how this specialist knowledge can add value to the organisation.

 

This part of the report is an opportunity for you to further develop a particular issue that may have been identified in your Part A analysis, but which now may benefit from further, more detailed, analysis, investigation or discussion using your specialist viewpoint. It needs to be an issue that may potentially impact, either positively or negatively, the future success of the organisation

 

It may be, for example, a developing issue in the macroeconomy or a variable arising from changes in the social environment that may impact stakeholder expectations somehow in the years ahead.

 

It may be, alternatively, an issue concerned with internal organisation factors that may impact future strategic success, for example, skills or capability issues.

 

The issue you identify needs to be relevant to your specialisation and needs to be relevant to the case organisation – this is how you are demonstrating your value.

 

Marking criteria:

 

The practicality, relevance and validity of the chosen issue to your specialist discipline

The quality, range and use of factual data gathered and applied (both quantitative and qualitative) to support your analysis and its relevance to the analysis

The demonstration of expert specialist knowledge and professional judgement in your analysis

The justification and support of recommendations or findings from the analysis to the organisation (that is, how successfully do your ultimate conclusions address the original issue identified and do they add value in some way).

Additional information/preparation:

 

Key activities/elements include:

 

Using your specialist knowledge (i.e. accounting, actuarial studies, economics, finance, human resource, management) and professional judgment to identify the issue(s).

Undertaking further research outside of the information presented in the case.

Arguing the case for your identified issue(s).

Explaining, interpreting and analysing the issue(s).

Developing and justifying actions to resolve the issue(s).

Deliverables (report parts A and B):

 

Report – 4250 words excluding appendices/references

 

The final report structure must contain the following elements as a minimum:

 

Executive Summary (250 words)

Part A (2,500 words excluding appendices/references)

Introduction

Sections with relevant headings describing the types of analysis you have performed (within the Strategic Management Cycle framework) to investigate and appraise the issues, and the outcomes of this analysis.

Summary of recommendations (in bullet point format).

Proposal and defence of how these recommendations are to be implemented (this will serve as a preliminary discussion for the consideration of the Board/senior management if they choose to proceed with the recommendations in the future).

Part B (1500 words)

Introduction

Discussion (use headings as appropriate to aid readability)

Conclusion

References.


Case study — Wesfarmers

 

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INTRODUCTION
In comparison to the rest of the world, the Australian market is a small one. For big
companies like the conglomerate Wesfarmers Ltd, options offering significant growth
locally are not easy to come by.

Yet the idea of expanding overseas is risky. Other Australian companies, seemingly
at the top of their game, have tried and failed to achieve the levels of success they
were hoping for. The banking sector is a good example – NAB has retreated from the
US and British markets after unsuccessful acquisitions over the years and ANZ is in
the process of reviewing its strategic push into Asian markets due to profitability not
being to the bank’s, or investment analysts’, expectations.
Nevertheless, Wesfarmers has now indicated to the market that it is to make a
significant step overseas. It intends to leverage its highly successful Bunnings home
improvement brand via the acquisition of the Homebase chain in the UK.
It’s a relatively modest investment. In relation to Wesfarmers’ market capitalisation of
almost A$50 billion, the purchase amounts to only A$700 million. It also builds on
Wesfarmers’ existing expertise and the company’s proven record of portfolio
management success. The risk, it seems, is manageable. What could go wrong?
The focus for Wesfarmers, just like any other large public company, is to achieve
sustainable growth. As Richard Goyder, the CEO of the company since 2005, states:
“In many ways, the number one challenge for CEOs is growth” (quoted in Gray,
2009). And Goyder is not afraid to achieve growth through acquisition.
Some say that the company transforming decision to take over the Australian based
Coles group of iconic retail brands in 2007 was the biggest risk of all for Wesfarmers.
The acquisition was a gigantic strategic move for the near 100 year old company.
And, it was to spend $A20b not knowing that the GFC was just around the corner.
* By Craig Terry, 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. Semester 1, 2016
CASE STUDY*
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The decision could have broken the venerable West Australian company’s almost continuous success. It didn’t. But the timing was appalling. Richard Goyder kept his cool. He had worked at it. He even gave up drinking coffee during the Coles negotiation (Gray, 2009). But some may say that he “bet the company” with the move.
It was a big decision as it stood; the impact of the GFC made it worse. Credit markets were seizing up just at a time when Wesfarmers had significantly increased its leverage to consummate the deal. The company had to engage in some hefty debt and heavily dilutive equity raising to appease nervous markets. Shares were issued at the time for $13.50 (they now trade at over $40). But, speaking in 2015, Goyder rejects the idea that he bet the company: “I don’t agree with that because Coles was always a very valuable asset. I might have bet my career on it, but I don’t think we bet the company” (quoted in Heffernan, 2015a)
As it turned out, his career has not only survived but has flourished. The Coles acquisition, while still a work in progress, is seen by the markets as a tremendous success. With financial discipline, the recruitment of the best international talent, and, some smart retail pricing strategies, Coles Supermarkets has been turned around and is now out-competing its arch rival Woolworths. This was very definitely not the case prior to Wesfarmers’ acquisition.
But having reasonably digested the Coles acquisition, new strategic challenges, like the latest Homebase move in the UK need to be continuously identified. This is what a “portfolio manager” does. The difficulty that has arisen, however, is that given the sheer size of the Coles acquisition, retail now forms the major part of Wesfarmers’ profile. And, this is exactly why growth strategies are not easy to identify. There are limits to growth in relatively small markets like Australia.
Some of these limits are political in nature. The retail market’s highly concentrated oligopolistic structure means that further significant acquisitions will not be allowed by regulatory authorities. Furthermore, attempts to improve profit margins by driving down cost of goods have been challenged by disgruntled suppliers saying that Coles and others are abusing their market power in negotiations with them. This has caused a major political backlash and has resulted in questions being raised about the supermarket groups’ ethics and those of its parent.
Other limits to growth are coming from stiff competition. Technological change has promoted the rise of on-line retailing and even within the traditional bricks and mortar business model, international companies are entering the Australian market. The German group, Aldi, in particular, is gaining an ever increasing share of the Australian grocery market.
Whatever the challenges, it seems that strategic decisions at Wesfarmers will always be made with a long term view. This has been a theme of not only the current CEOs tenure but also of the company generally.
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Goyder says that there is a long history, including the Coles acquisition, that shows that decisions are made with a long [economic] cycle in mind and that they will not be “side-tracked by short-termism. The board has always taken a long-term view”, he says. “If the board doesn’t get side-tracked, management doesn’t get side-tracked” (quoted in Heathcote, 2013)
WESFARMERS: PAST AND PRESENT
The company’s reputation as a highly successful portfolio manager is unquestioned. Its model is one of a classic manager of a portfolio of diversified investments. But it’s the way that these investments are actively managed that Wesfarmers’ would argue is how value is added.
A contrary view is taken by some market analysts who believe that the era of diversified conglomerates has passed. Amongst other reasons, it is argued that shareholders find it difficult to see the need for the existence of a corporate head office sitting on top of individual businesses. Why not allow shareholders to invest in these businesses directly?
The board and senior management of Wesfarmers would disagree. They believe that it is the strategic skills of a corporate “parent” that adds value at Wesfarmers. Goyder says it’s the financial discipline that sets Wesfarmers apart from other multi-business firms. “We are hugely financial focused. We’ve got financial DNA running through the bloodstream of the organisation” (quoted in Gray, 2009)
The Wesfarmers company believes that it is this financial discipline that will add value to any business it acquires. Bob Every, the recently retired Chairman of Wesfarmers knows the formula well: “Goyder and previous Wesfarmers CEOs have all run the business to maximize return on capital and at the same time have recognized that you have to step out every so often with a company changing transaction to achieve growth. You need both growth and a focus on return on capital to sustain growth in shareholder value” (Featherstone, 2009)
The company also takes the “long view” with its investments as previously noted. It helps when it has had one of the most stable board and management structures of any blue chip Australian company. This has been a feature from the time it started 100 years ago.
History* The Westralian Farmers Ltd, commenced operations in 1914 providing services and merchandise to the farming community in the vast state of Western Australia. Its primary aims were to: * Historical information has been largely taken from Thompson, P (2014)
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– Conduct merchandising activities including import/ export of rural products; – Act as auctioneers and agents; – Provide facilities for the sale, in any part of the world, of products of the land; – Charter ships for the movement of produce; – Publish its own newspaper. So even at its birth, while Wesfarmers very definitely placed itself in the rural sector, it started out with diversified purposes. Being a farmer in Western Australia in the early 1900s required resilience. Many were far away from main population centres like Perth, the state’s capital, let alone the eastern states several thousand kilometres away. The idea of a “cooperative” where farmers (members) got together and pooled resources to help each other both purchase requirements at good prices and sell produce cooperatively, rather than as competitors, had some appeal. It was also a matter of pride for West Australia and its farmers that rural industry could be successful without the involvement of other powerful interests: that they could do it “on their own”. Upon the sale of a successful wheat harvest in the 1924-5 season where the company (with others) were involved in the sale of the state’s wheat crop under a “pooled” marketing scheme, The West Australian (the major newspaper in WA) noted that: “[it] is indeed a feather in the cap of the Western Australian farmers that, although in numbers and financial strength they do not compare with the farmers of the eastern wheat growing states, they have been able through their organisation to finance two successive harvest without going, like their eastern brethren, cap in hand either to the Federal or State governments or to the Commonwealth for guarantees and, further, without surrendering a particle of control over their marketing operations” (Thompson, 2014 p88) After World War 2, the company believed that it should diversify into non-agricultural areas. Major developments were the growth of a large land-based transportation business and the movement into the retailing of gas (LPG). In the 1970s, it then purchased management control of a fertiliser company CSBP. It saw the acquisition not in terms of just becoming a major player in the supply of agricultural fertiliser but the then CEO John Bennison “saw that CSBP had a whole lot of very bright engineers who had knowledge which extended beyond fertilisers into chemicals and through chemicals into a much wider sweep of industrial operations” (Thompson, 2014, p15)
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A further company defining move was its listing on the ASX in 1984. This was a change to circumvent some of the financial structure and legal limitations of being a cooperative. It also changed its name to what we now know the company as, Wesfarmers Ltd. The company’s listing was obviously a big step. And in some ways, one that moved the company beyond its cooperative past to becoming a “modern’ corporation. But there were still strong links back to agriculture. On the company’s 75th anniversary in 1989, Harry Perkins the 8th Chairman who liked to describe himself as “just a farmer from Belka [WA]” summed up Wesfarmers success in the following way: “The company has been managed and influenced by men of vision who have been supported by others with the skills and persistence to make their ideas work for the benefit of shareholders and the rural community in general” (quoted in Thompson, 2014 p20) Succession These strong historical linkages over the long span of Wesfarmers life as a company has no doubt contributed to its continuity even through times of major change such as big acquisitions. It is testimony to the stability of the company that there have been only seven CEOs in its 100 year history. The four most recent CEOs met at the company’s 100th anniversary dinner and these represented 41 years of that history (Figure 1). Compared to most major companies where CEO longevity tends to be short, this represents quite an achievement.
Figure 1: The most recent CEOs of Wesfarmers LtoR: Trevor Eastwood (1984-1992), Michael Chaney (1992-2005), Richard Goyder (2005-current) and John Bennison (1974-1984). Source: www.wesfarmers.com.au
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The current CEO, Goyder has been in the position since 2005. He was formerly the Chief Financial Officer of Wesfarmers so he knew the company well when he assumed the role. He knows he has a long history of successful CEOs to follow but he is conscious of being himself and not trying to be someone else or something he isn’t. Speaking after only a year in the job he says that his style of leadership is different. “[But] it’s been effective for me before” he says”, and I trust it will be as we go forward. Part of my leadership style is being frank and open with people and being clear about what we are trying to achieve. I think that as a leader, telling people what’s really going on, keeping them informed of decisions is probably the most powerful tool you have” (Morgan 2006 p7).
An interview of Goyder from 2013 explaining his background, outlook and experiences at Wesfarmers can be seen at: http://www.thebottomlinetv.com.au/interview/sneak-preview-richard-goyder/
The number of chairman during the company’s history, has been almost equally as stable. Bob Every, Wesfarmers’ recently retired 10th chairman, had been in the role for the last seven years; critically, through the phase of the company bedding down the Coles acquisition. In his place as chairman is the 65 year old, and, interestingly, former CEO, Michael Chaney.
Some see this as continuing the theme of stability. Others see it as poor governance – former CEOs shouldn’t become chairman. It’s argued that they’re too close to the company’s history. Former CEO of the Commonwealth Bank of Australia (CBA), Sir Ralph Norris, for example, says that he “would never join the board of the [CBA] and would not expect to be asked. The last thing the new CEO needs is the former CEO questioning his or her strategy” (Featherstone, 2015 p26).
But both Chaney and Every disagree. “[T]he company has changed quite a lot since I was there in terms of size”, Chaney says, “….having been out for 10 years, I can adopt a truly independent state of mind. Every agrees: “[s]ometimes corporate governance can be too squeaky clean” (quoted in Mitchell 2015a). Indeed, there is a precedent here: former CEO Trevor Eastwood (1984-92) also came back as a chairman (2002-08).
The return of Chaney is in keeping with the Wesfarmers culture. He says he wants to maintain the company’s “rare shareholder-focused culture as opposed to an empire building self-aggrandisement culture” (quoted in Mitchell 2015a). This view is shared by Every speaking at a recent dinner celebrating Wesfarmers’ 100 years: “Our culture came from our old co-operative days where we were here for our members, not just to build an empire” (quoted in Gould 2014)
Corporate Activity
In 2016, it certainly is an empire but a very successful one. Since listing, Wesfarmers has delivered compound annual growth in total shareholder return (TSR) of over 20 per cent, substantially out-pacing the rate of TSR growth achieved by the market as represented by the All Ordinaries Index. This is shown in Figure 2.
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Figure 2 Wesfarmers TSR performance since ASX listing
Source: Wesfarmers (2015a)
This has been during a time of significant corporate transactions. Figure 3 shows the transactions undertaken by Wesfarmers since its ASX listing beginning with the full 100% acquisition of CSBP. Standout transactions include the acquisition of Bunnings (hardware/home improvement) and then the BBC hardware stores a few years later to consolidate Bunnings position in this market.
Wesfarmers management believes that it’s the financial “know-how” they bring to investments that makes the company a success even if they don’t have experience in the underlying business. Its move into coal in the late 1980s is a prime example. A senior Wesfarmers executive summed up this move in the following way: “We knew nothing about coalmining and up until then we more or less tried to do bolt-on things or things we knew something about. This was the first acquisition where the philosophy was, ‘Look, we’re great managers. We know how to manage. It doesn’t matter what the business is, we can manage it, so let’s go for it’” (quoted in Thompson 2014 p210)
The company has also made some major divestments. Landmark, their rural services division which included Dalgety, was sold in 2003 (proving Wesfarmers was not wedded to the agricultural sector for the sake of sentiment!) and, recently, the divestment of its Insurance underwriting and broking business.
But Coles was the big transaction. Prior to the acquisition of Coles, Wesfarmers most significant individual business was the very successful Bunnings home improvement chain. Figure 4 shows the size of each segment at the time of the takeover
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Figure 3 Wesfarmers Corporate transactions since ASX listing
Source: Wesfarmers (2015a)
Figure 4 Wesfarmers by Segment
Source: Coles Group Scheme Booklet Supplement 2007
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The acquisition of Coles was a stand-out event; this is made very clear from the diagram (see Figure 5). Coles is a retailer but is a diversified retailer in its own right. Businesses operated by Coles Ltd include:
– Coles Supermarkets (including liquor and express)
– Target
– Kmart
– Officeworks
Indeed, after the acquisition, it would be fair to say that Wesfarmers had been transformed from a diversified conglomerate to a diversified retailer!
In its latest full year results (2015), the break-up of Wesfarmers into its segments is shown in Figure 6.
Figure 5 Shares of business types at Wesfarmers before and after the Coles acquisition
Source: Coles Group Scheme Booklet Supplement (2007) (Note: Bunnings, which was formerly part of the Home Improvement Division is now part of Big Box Retailing i.e. large retail format stores (also includes Officeworks)
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Figure 6 Shares of business segments at Wesfarmers as at the end of the 2015
financial year
Source: Wesfarmers (2015c)
The segment results for prior years are shown in Figures 7 and 8.
Figure 7 Shares of business segments at Wesfarmers as at the end of 2013
Source: Wesfarmers (2014a)
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Figure 8 Shares of business types for 2011/2012 financial years
Source: Wesfarmers (2012)
Coles is clearly the largest brand within the Wesfarmers group. This is followed by
Bunnings in the Home Improvement category. Bunnings, has been a major success
since its commencement in the early 1990 and it is because of this that the company
wants to leverage this success overseas.
It was also due to this success that Wesfarmers main rival, Woolworths, has tried to
emulate this with the start-up brand, Masters. But, it has only just been announced
that Woolworths are now divesting itself of the brand in the near future due to large
and sustained losses. This will be discussed later. The relative market shares prior to
Woolworths’ decision to close down the Masters brand are shown in Figure 8a.
Figure 8a Hardware and Building Supplies market shares in Australia
Source: StreetTalk (2015)
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Other segments of Wesfarmers are:
 Resources: the extraction of steaming and coking coal from its mines in Curragh (Queensland) and Bengalla (NSW);
 CEF (chemicals, energy and fertilizers): supplies ammonia, nitrates and chemicals to the gold mining industry, fertilisers through its CSBP company, and LPG and Natural Gas through Kleenheat;
 Industrial and Safety: provides industrial and safety equipment across broad range of industries and also provides consulting services in safety and environmental risk management;
 Insurance (mostly sold during 2014); and,
 The three other brands acquired in the Coles transaction,
– Officeworks,
– Kmart
– Target.
While there has been some recent improvement, the Target brand has been chronically underperforming. Kmart on the other hand has in recent years recovered from a period of underperformance itself. Given that they are both “discount department stores” and hence, stock similar ranges, there inevitably is going to be some cannibalisation of sales between the two brands.
Wesfarmers maintain that there is room for both in its portfolio and denies that they will try to off-load one or the other. When they were both part of the Coles Group, it was also believed that there was room for both. But, it has been rare that both brands have fired simultaneously. The problem for Wesfarmers (and before it, Coles) is that if one was sold to, say, a private equity firm, it would immediately become a competitor. Some may argue, therefore, that it is safer for Wesfarmers to retain the status quo.
Retailing, however, has generally been good to Wesfarmers. While there are some weaknesses across the portfolio, the company has built on its experience and success with the Bunnings home improvement, and, its takeover of Coles, and has leveraged this across its business.
Performance
But while there has been turnaround success for its biggest segment, Coles Supermarkets, some analysts believe that Wesfarmers paid quite a high price for the acquisition when it comes to the metrics of return on equity (ROE) and Earnings Per Share (EPS). Latest 5 year results for EPS are shown below.
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Figure 9 EPS 2011 to 2015
Source: Wesfarmers (2015d).
And for the 5 prior years:
Figure 10 EPS 2006 to 2010
A
Source: Wesfarmers (2010a)
When it comes to return on equity (ROE), the last 5 years’ results show a consistent
improvement after having to digest the huge Coles acquisition. It represents around
a 50% improvement since 2010 when ROE was only 6.4% (Wesfarmers 2010a).
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Figure 11 ROE 2010 to 2015
Source: Wesfarmers (2015d)
But when these numbers are compared to ROE performance prior to the Coles acquisition, some have argued that there is still some way to go to emulate the kind of investment performance that was seen as a hallmark of the Wesfarmers conglomerate business model.
As remarked in a major financial daily after Wesfarmers’ results for the 2013 year were published: “[d]uring the golden years, Wesfarmers reported return on equity that exceeded the returns achieved by most Australian companies thanks to strategic acquisitions and disposals of assets. [But] shareholders in 2013, used to Wesfarmers’s recent return on equity of around 8 per cent, may be shocked to know how far this performance is from the returns in the five years to 2007”. The ROE in 2007 was 25.1 per cent. (Chanticleer 2013).
Capital employed figures (as defined by Wesfarmers internal reporting) for each segment for the years 2011 to 2015 are shown below in Table 1:
Table 1 – Capital Employed by Segment
2015
2014
2013
2012
2011
Coles
16,276
16,272
16,114
15,544
14,973
Home Improvement
3,244
3,343
3,492
3,250
2,863
Office Supplies
1,034
1,097
1,147
1,208
1,195
Target
2,466
2,979
2,930
2,911
3,359
Kmart
1,312
1,361
1,329
1,423
8562
Insurance
1
1,497
1,396
1,291
1,260
Resources
1,453
1,459
1,480
1,488
1,293
Chemicals,Energy,Fertilisers
1,535
1,539
1,400
1,282
1,298
Industrial and Safety
1,257
1,127
1,119
1,187
1,272
1 Insurance segment divested in prior year
2 $486m of goodwill reallocated from Target to KMart in 2012
Source: Wesfarmers (2011, 2012, 2014b, 2015d)
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Wesfarmers overall performance for the period 2011 to 2015 can be viewed at the following site: https://www.wesfarmers.com.au/investors/shareholder-information/five-year-financial-history.html
In its review of 2015 results, the company defined its overarching framework to achieve satisfactory financial performance. It calls this the “Wesfarmers Way”. The framework is shown in Figure 12.
Source: Wesfarmers (2015d)
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On the issue of sustainability, one of the company’s “value creating strategies”, Wesfarmers takes seriously its responsibilities to all stakeholders not just shareholders. It also notes its commitment to: appropriate governance structures and processes; gender and racial diversity; human rights; sustainability; and the need for the company to have transparency in the way that it calculates and pays its taxes. Goyder has recently spoken up about the issue of corporate tax transparency. He believes that corporations should be required “to pay tax in the communities in which they operate……My personal view is that the tax issue will become a bigger one for companies and will go directly to their reputation”. (Hawthorne 2014). His voice has some weight not only being the CEO of one of Australia’s largest corporations but also in his recent capacity as chairman of the B20 business summit.
Of course, financial performance is also paramount and Wesfarmers has a clear “road-map” of how to achieve this. The company’s 2015 strategy briefing day showed the following diagram explaining how shareholder returns are actually delivered:
Figure 13 The Wesfarmers Approach to Shareholder Returns
Source: Wesfarmers (2015a)
As well as the underlying profitability and cash flow generation ability of Wesfarmers’ businesses, the other key enabler for growth is balance sheet strength. As a public company, it always has recourse to the equity markets. But apart from the time of the Coles acquisition when the GFC was impacting hard, equity issues are not always seen as first choice particularly if debt funding is available and relatively cheap. In fact, during the bidding duels for the Coles acquisition, Wesfarmers found that its balance sheet strength and relatively low cost of debt was a key advantage over its private equity rivals (Thompson 2014 p263)
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The GFC, however, taught many companies some lessons about risks of debt and
Wesfarmers is no exception. Debt management is clearly an important objective.
Some metrics from the 2015 results show Wesfarmers’ debt positioning:
Figure 14 Wesfarmers Debt
Source: Wesfarmers (2015c)
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Structure
Even with the actions taken to digest the huge Coles deal, return on capital is still the most important performance hurdle for Wesfarmers’ senior management. While performance may vary from to time, this key objective hasn’t changed in the company’s modern history. Making people accountable is also critical.
Take Wesfarmers’ CEO in 1980’s and 1990’s for example. Trevor Eastwood was named Entrepreneur of the Year at the Enterprise Australia Awards in 1989. In his acceptance speech he said that the adoption of return on shareholder investment as a company policy was vital: “We adopted that as a policy and introduced a whole planning system based on that one premise. We set target rates for people and the level of returns they ought to get at various levels in the company. This caused people to concentrate on the things that really mattered in life and we started to see tremendous growth in profitability which generated funds that we were able to invest in further diversification and gave us additional growth. When we started, we were returning less than 10 per cent on our shareholder funds and today [1989] we are returning 22 per cent” (quoted in Thompson 2014 p211)
This credo is still evident. Bob Every, the recently retired chairman, described his philosophy on running a conglomerate: “First of all you have to have a clearly defined strategic business unit. Then once you get clearly defined businesses you need to put a person in charge who is a world-class CEO in his or her own right, make them feel as if they’re running their own company, reporting to a board, albeit maybe a management board…Thirdly, you have to have a small head office that plays banker and defines what I call ‘loose/tight’ – tight things must be adhered to; loose things you draw boundaries around and give freedom to act within those boundaries” (quoted in Thompson 2014 p255)
Wesfarmers current corporate structure, as at the end of 2015, is shown below.
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Source: Wesfarmers Annual Report 2015e
So having the overarching objective, and, the structure in place, how exactly then does Wesfarmers intend to deliver these long term shareholder returns?
One way is to make another acquisition. This is clearly something that Wesfarmers thrives on; indeed investors expect it. In its latest briefing, Goyder impressed the fact
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that the business has a disciplined approach to acquisitions. Opportunities need to fulfil a number of criteria before they are considered – see Figure 15
Figure 15 Wesfarmers Investment Approach
Source: Wesfarmers (2015a)
Goyder says that they have to be “sensible” when thinking about deploying capital expenditure. Even though the company is under constant pressure to make another acquisition, Goyder says that he felt more confident in re-investing in current businesses: “[We] recognise that some of the best investment decisions we can make are in growing the businesses we are already in” (Mitchell & Greber 2015).
In the absence of a major acquisition that may yet again be a company transforming one, Wesfarmers’ short term quest for investment returns is going to be focused it seems on its current best performers. The problem is: each of these brands are already quite dominant in highly concentrated industries. And, given that Coles has the biggest impact on the group’s results, where will earnings growth for Wesfarmers actually come from? Will relatively small acquisitions like Homebase be enough? Can the all-important supermarket earnings grow? What other retail categories should the company pursue? Or, is it indeed more a matter of protecting its position in the markets they already operate in – particularly the vital supermarket space?
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THE RETAIL INDUSTRY
Wesfarmers current reliance on retail, as opposed to other business sectors suggests that in the absence of a major acquisition elsewhere, retail will remain critical to its success. This is not necessarily a bad thing. From an ROE perspective, it is a good performer. Figure 16 shows that return on shareholders’ funds in retail, on average, are higher than most other sectors.
Figure 16 Return on Shareholders Funds
Source: Productivity Commission (2011 p44)
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 in Figure 17
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Figure 17 Retail Trade Turnover by Sector
Source: Productivity Commission (2014 p39)
The size of each sector in terms of profit and margins is shown in Table 2.
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Table 2 Performance Indicators for the Retail Industry 2012-13
Source: Productivity Commission (2014 p43)
So while returns are relatively high in the retail sector as a whole, there are
differences within each of the sub-sectors. This is evident in terms of profitability, but
also in terms of revenue and industry growth. Figure 18 shows growth in revenue for
each sub sector over the last decade.
Figure 18 Quarterly Growth in retail Turnover
Source: Productivity Commission (2014 p44)
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When viewed over longer time horizons, retail trade as a whole is susceptible to changes in the macroeconomic environment. The Global Financial Crisis (GFC) had an impact on the economy generally and retail activity was sensitive to this economic shock. Consumer confidence clearly took a hit as shown in Figure 19.
Figure 19 Consumer Sentiment since 1990
Source: Mason (2015)
One way that households reacted to the GFC was to increase their level of savings. Figure 20 shows that after zero or even negative savings ratios before the GFC, these have now reverted to significantly higher rates of around 10%. This may have an impact on household consumption, and, in turn retail spending.
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Figure 20 Household Savings
Source: Mason (2015)
It is also the case that household debt is historically high. To some, worryingly so.
Figure 21 Debt per person in Australia
Source: ABS (2015)
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The rise in the levels of household debt has, at least in part, contributed to the high property prices currently being experienced particularly in Sydney. This may be a “double-edged sword” for the outlook of consumer confidence generally. While low interest rates help, high debt requires increasing levels of servicing. But, some observers see a significant “wealth effect” from higher property prices – at least for homeowners. The recently replaced CEO of Woolworths, Grant O’Brien certainly thinks so: “People talking about the value of their homes is part of how people get confidence” (quoted in Mitchell 2015b). This may be fine, as long as rates stay low and/or house prices stay up and don’t deflate within a “bubble” type scenario.
Recent concerns about the impact on the macro economy of declining commodity prices have also had a significant impact on the nation’s company profits. This has appeared to have had some spill on effect to wages. If profits decline, it is likely that wages will follow and this will also impact household disposable incomes and consumption.
Figure 22 National Incomes
Source: Uren (2015 p2)
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. But in the absence of any major expansionary fiscal or monetary policies (over and above anything currently in place), companies will find it difficult to find profits as the economy continues to feel the effect of low international growth and a fading resources boom.
Matt Sherwood, head of Investment Strategy at Perpetual believes that weaker economic growth can expose companies with weak strategies: “[F]avourable macro conditions can camouflage things when there are potential flaws in corporate strategies”, he says. [The current] economy is going to expose the weaknesses that are there” (quoted in Evans et al 2015)
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However, of all the retailing categories, food would be least susceptible to fluctuations in household consumption and expenditure. Moving away from these categories into more “discretionary” areas may represent a risk in the event of a major external shock and/or domestic recession. The varying growth rates of revenues over the last decade as shown in Figure 18 seem to indicate that different retail sectors have different characteristics that need to be considered.
Wesfarmers’ current weighting in the supermarket sector is possibly a good thing – at least in so far of reliability of earnings. But is there potential for satisfactory growth?
The Supermarket Industry
Of all the retail sectors, there are few that have a higher profile that supermarkets. These are the retail stores that provide most of our daily or weekly basic needs. When consumers start thinking about “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. Some momentum is gathering.
The main players in the Australia are:
– Woolworths
– Coles
– Aldi
– Metcash (through the IGA brand)
The relative proportions of market share are shown in Figure 23.
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Figure 23 Australian Grocery Market Shares
Source: Roy Morgan (2015)
Coles Supermarkets
Coles operates over 750 supermarket stores around Australia. The supermarket business is split between:
– Coles Supermarkets
– Coles Liquor (Liquorland, Vintage Cellars, and, First Choice)
– Coles Express operating within the alliance with Shell petrol service stations
– Coles On-Line (internet retailing)
The alliance with Shell means that Coles is able to operate Coles convenience stores at a location of high customer traffic (at the service station). It also owns hotels in Queensland as state laws require that liquor stores can only be operated as part of a hotel liquor license in that state.
The previous 5 year results for the Coles segment are shown in Figure 24.
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Table 24 Revenue and EBIT for Coles Supermarkets 2011 to 2015
Source: Wesfarmers (2015e)
The store profile of Coles is shown in Figure 24a
Figure 24a Coles Store Statistics
Source: Wesfarmers (2015f)
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By way of comparison, in 2010, there were 742 Supermarkets, 766 Liquor Stores, 96 Hotels and 619 Convenience stores. Total supermarket selling area was 1,586,494. (Wesfarmers 2010b). While there has been some growth in stores and store area this is not the only contributing factor to segment overall performance.
The group has recently seen the departure of Ian McLeod after a successful few years at the helm of Coles. He moved into a corporate role in July 2014 in an apparent succession move but has now left Wesfarmers altogether to take up a position with US retailer Bi-Lo. He was appointed shortly after Wesfarmers acquired Coles and his performance has been rated by some commentators as one that will go down as one of the greatest retailers in Australian history (Knight 2015).
In terms of sales growth relative to Coles’ biggest competitor Woolworths – the “duopolists” naturally see each other as arch rivals – McLeod’s success is clearly shown in the following graph. Growth in “same-store sales” (stores open for more than one year) for Coles has exceeded Woolworths each quarter since 2010.
Figure 25 Same store sales growth – Woolworths/Coles
Source: Greenblat (2015a)
Market shares as shown in Figure 23 also points to McLeod’s success in halting an alarming deterioration in relation to Woolworths around that 2007-9 period when he took on the CEO role.
It has not been without some controversy however, particularly in respect to Cole’s apparent treatment of suppliers and the implementation of aggressive pricing for staple items such as milk. Coles is not alone on this. Woolworths has also taken some flak. More of this later.
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With McLeod’s departure, new CEO John Durkan, himself highly regarded (and also from the UK), has put his own stamp on Coles’ agenda planning to build on McLeod’s success. He summarised this in the May, 2015 strategy briefing day to investors (Wesfarmers 2015a). Figure 26 itemises 7 key planks that are seen by Durkan as crucial for ongoing success. He has even gone so far as rating Coles’ performance on these planks compared to world’s best practice.
Figure 26 Coles Strategy
Source: Wesfarmers (2015a)
Clearly, while Coles has made progress, his ratings suggest that there is scope for more! Key points of this strategy include:
1. A focus on freshness – more product lines are fresh food and creating more strategic long term partnerships with selected suppliers
2. Value – creating customer trust through price leadership
3. Store Network – closing poor performing stores and ensuring store configurations are right
4. Simplicity – Maintaining an efficient supply chain
5. New channels – online and joint ventures (e.g. credit card)
6. Transform Liquor – turning around this underperforming segment through store management and pricing strategies
7. Careers – skills development and training
Durkan has a strong foundation after the 5 successful years Coles has enjoyed under McLeod. Woolworths, Coles’ traditional rival, has felt the heat of this during this time. But this may not last. Woolworths originally was a performance leader – it wants to regain this position. And, the threat of international retailers is increasing.
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This is not to mention the potential for on-line retailing to change the structure of the industry. Coles, along with any business operating in turbulent industries, needs to ensure it keeps innovating.
Woolworths
Woolworths has around 930 supermarket stores around Australia (and over 200 in NZ) and is the largest supermarket chain (Woolworths 2014). In addition to supermarkets, it operates as part of the same segment:
– Liquor stores (BWS, Dan Murphy)
– Woolworths petrol
As for Coles, Woolworths has an alliance with the petrol retailer, Caltex, and so competes head-on with Coles in fuel retailing. Woolworths also operates two other major brands:
– Big W, a discount department store (this brand is a direct competitor of Wesfarmers’ KMart and Target); and,
– Masters, a home improvement start-up that was meant to be direct competitor to Wesfarmers’ hugely successful Bunnings.
The Masters brand has turned out to be a disaster for Woolworths. Ironically, on the very same day that Wesfarmers announced its proposed acquisition of the British Homebase hardware chain, Woolworths announced that it was divesting itself of the Masters business.
As previously noted, prior to Wesfarmers takeover of Coles, 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.
Fast forward to 2016 and the market now thinks that Woolworths has moved away from this model; at its peril. The recently replaced CEO of Woolworths, Grant O’Brien flagged in 2015 lower than expected profit growth – Woolworths’ share price was punished accordingly. The major criticism has been that the company has fattened its gross margins at the expense of sales.
The following graph (Figure 27) clearly shows this trend:
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Figure 27 Woolworths Gross profit Margins 2008 to 2015
Source: Mitchell (2015c)
In a 2015 strategy briefing to analysts, O’Brien admitted that it had lost sight of its customers. This is seen by some analysts as an acknowledgement that prices needed to be reduced (indeed, $500m had been committed for that purpose): “if we address customers successfully” Obrien stated, “sales momentum comes. If sales momentum comes, margin comes. Margin is an outcome” (quoted in Heffernan 2015b). This strategy was described in the following 2 diagrams:
Figure 28 Woolworths Strategy
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Source: Woolworths 2015
While Woolworths will not only go after sales growth by price reductions alone, it clearly is front and centre of their thinking now. As if to emphasise this, CEO Grant O’Brien, as we have now seen, has been moved aside and Brad Banducci, the supermarket division’s boss has taken his place. Banducci is now looking to re-establish a retail fundamental – satisfied customers
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 23).
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 (Australian Competition and Consumer Commission 2008). 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 2015c)
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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 recent 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.
Aldi’s profit results for its Australian operation for the years 2010 to 2013 were (table 3):
Source: Aldi (2015)
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 2014a). 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 2015d)
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 29 clearly shows the impact of the discounters.
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Figure 29 UK Market Shares
Source: Farrell (2014)
The major players have responded to this threat in the only way they feel is right – by lowering prices. Moody’s, the credit rating agency, believes that the majors in UK will have to continue to reduce prices to slow the pace of falling sales: “We believe Aldi and Lidl are now entrenched and their combined market share could reach 10% over the next couple of years from 8.3% today” (quoted in Farrell 2014). There will no let-up in the pressure on the big grocers; Morrisons boss says that it is the biggest upheaval in the sector since the 1950s. 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” (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. Market share data in Figure 23 tends to support this.
Metcash is a wholesaler and distributor of groceries to the IGA chain of independent supermarket owners. It is a “banner group” agreement 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.
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While there has been some recent recovery in the Metcash share price, in June of 2015, shares in Metcash plunged by about 20% after it announced that it would not pay a dividend for 18 months and that it would have to take a $640m writedown in assets. It is continuing to cut prices to match the competition. For one fund manager the message is ominous: “For the last 24 months there’s not been one iota of good news that’s come this company’s way. The future looks bleak” (Mitchell 2015e).
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. It is a new market entrant that other retailers will need to take note of even if competition appears to be more localised at this point of time.
More Overseas Competition?
The other German supermarket group, Lidl, has already been mentioned. Even though they have an extensive presence worldwide (and is bigger than each of Coles and Woolworths) they are yet to formally enter the market notwithstanding continued speculation of this.
But this is just part of a recent trend of new stores entering the Australian retail industry generally. When examining international retail brands, Australia has in fact a surprisingly small presence of these.
The following figure describes the nationalities of brands across all the retail trade sectors that operate in Australia. It shows the 37 of the 250 top international retailers that operate in Australia. Of these, 49% are US. Interestingly, there are only 8 Chinese in the top 250 and none of these operate in Australia. The big point here is that 85% of the top 250 do not operate in Australia.
Figure 30
Source: Deloitte 2015
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While Figure 31 (below) shows that these international brands are mostly in non-food areas, it seems clear that Australia is susceptible to greater levels of international competition. But this is not the only threat to Australia’s domestic supermarket companies. Technological disruption has also opened the retail industry up to a truly international market place.
Figure 31
Source: Deloitte 2015
Online retailing
The high Australian currency experienced during the mining boom certainly helped this trend. 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.
Local retailers believe that they are at a disadvantage, not only through potential currency effects but through the favourable tax treatment of international purchases. Currently, purchases under a $1000 threshold are GST free. Some retail industry players see this as unfair; consumers, on the other hand, probably see this as a “bonus”.
It is a highly charged political debate. And, it has been going on for some years now. In 2011, the then Labor government instigated an enquiry through the Productivity Commission into the economic structure and performance of the Australian retail industry (Productivity Commission 2011). This included a review of the current tax regime. It found that the issue of the GST “low value threshold” of $1000 was only a
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minor competitive advantage for local retailers, and further, that the costs of implementing a tax for merchants and tax authorities would outweigh the revenue benefits.
Nevertheless, the Commission did acknowledge the potential desirability of lowering the threshold on “tax neutrality” grounds. So, it remains a political issue. In the lead up to the 2015 budget, the current Liberal government ruled out any change.
The issue of GST on international transaction probably affects non-food items more than groceries, particularly perishable items. To this extent, Wesfarmers’ Target and KMart and Woolworths’ Big W brands possibly experiences some incremental impacts on revenues due to this emerging channel.
For the supermarkets, what would be more important is the rise of domestic on-line retailing and the potential niche start-ups nipping at the heels of the giant chains. Estimates of total retail spend on online have been put at around $16b which is around 6-7% of total sales generated by so called “bricks and mortar” retailers. (Heffernan 2014b).
The proportion of total online retail sales is relatively low compared to international figures. Estimates vary but Savills Australia researchers put this ratio at 11.6% in the US and as high as 13.5% in the UK (cited in Johanson 2015). A recent Government inquiry also identified Australia as being a “laggard” in picking up online sales – Figure 32 (Productivity Commission 2014)
Figure 32 Australia’s relative performance in online retailing
Source: Productivity Commission (2014 p23)
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In respect to groceries specifically, while neither Coles nor Woolworths break out their sales data, it is estimated that Australians are spending online between $2b to $2.4b on groceries annually and this represents 15% of total online retail sales making it third behind homewares (17%) and Department stores (34%) (IBISworld 2015a; Heffernan 2014b). This is from a total grocery shopping spend of approximately $94b (IBISworld2015b). In the UK, it is estimated that 12% of grocery shopping is online (cited in Mitchell 2014a). This compares starkly to Australia’s approximately 2%.
The international consultants A.T. Kearney believe that the supermarket duopoly of Woolworths and Coles is under additional threat from online shopping. Speaking at an Australian Food and Grocery Council annual conference in 2014, Michael Brown, the firm’s global consumer and retail partner pointed to a collapse in duopolies in electronics, books, homewares and toys in the US in recent years due to online penetration. So, “[if] we look forward to what could happen in grocery and fast moving consumer goods, the [internet] is opening up the door for very specialised niche players to come into certain segments and start to siphon off volume which could eventually lead to the inability of the duopoly to compete and to be able to service the market in the way they do today” (quoted in Mitchell 2014a).
Indeed we are already seeing this in Australia. Companies like HelloFresh, Kogan Pantry, GroceryRun, My Food Bag and Lite n Easy are all offering a food offering either as a “shopping service”, prepared meals, menu design or other variation in this space. It is estimated that there are currently over 400 online grocery businesses (Jones 2015). All small. All niche players. But all offering something that customers value it seems over and above what they are currently getting from the major chains.
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 33.
Figure 33 Online customer value drivers
Source: cited in Hartge-Hazelman (2011 p10)
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In the bricks and mortar world, there also seems to be a number of value drivers. An
ACCC inquiry into the supermarket industry conducted a survey and came up with
the following results: see Figure 34
Figure 34 Factors rated as “very important” by customers
Source: Australian Competition and Consumer Commission ACCC (2008 p72)
The major chains clearly also have a view on this. Woolworths included the following
summary in their 2015 Strategy Briefing:
Figure 35
Source: Woolworths (2015 p25)
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The company also splits up customers into particular segments:
Figure 36
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 37), 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 37 Woolworths Data Management Model
Source: Woolworths (2015)
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:
Figure 38
Coles’ long running and seemingly highly successful “Down
Down” campaign
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Figure 39 Woolworths’ “Cheap, Cheap” campaign
Figure 40 Aldi’s bold statement of being home to the lowest prices: “put us to the test, compare us to the rest”
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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.
Choice of strategy probably depends on a number of factors but according to Nielsen data, currently about 40% of groceries are purchased on special or promotion each week (cited in Mitchell 2015f). Supermarkets clearly push pricing and this probably explains why so many letterboxes around the country are full of “this week’s” promotional material!
SUPPLIERS
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.
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According to a report produced by the financial services firm, UBS and the Australian 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 (Mitchell 2015g). 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 2015a)
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. Coles and Woolworths see that they need to catch-up. Maybe not to the extent of Aldi, but Australian supermarkets see it as a growth opportunity compared to the UK experience, for example. Tesco, and, Sainsburys, have around 40% of their range in private labels; in the US its 25% penetration. In Australia, according to Nielsen data, it’s growing rapidly: in 2014, sales growth in private label brands increased by 6.6% compared to grocery sales growth of only 2.4%. Private label groceries now account for 21% of packaged grocery sales compared to 18% two years ago. (cited in Mitchell 2014b)
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 Kelloggs 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, 2015h)
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 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
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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. This will add to any practices that the big retailers currently have in place. For example, in Wesfarmers, 2015 Sustainability Report (Wesfarmers, 2015g), the retailer makes clear its existing stance in respect to suppliers: Our relationship with our 15,000 suppliers across the Group is very important to us. We want to provide better value to our customers and sustainable growth for our suppliers and their employees. Striving for better efficiency in our consumer supply chains ensures their continued competitiveness. Coles is our largest consumer business and its relationship with food and grocery suppliers in Australia continues to be the focus of some attention. To achieve everyday low prices for customers, Coles has been increasing the efficiency and cost-competitiveness of its supply chain. This has been challenging for some individual food and grocery suppliers, but has enabled the purchase of significantly greater volumes of fresh food from Australian suppliers. Strengthening its relationship with its suppliers is a key focus for the Coles team. Wesfarmers also has an extensive number of international suppliers. This adds a further dimension in how suppliers need to be managed. The 2013 Rana Plaza building collapse in Bangladesh where over 1000 garment workers were killed created a wave of concern over how large western companies were potentially exploiting poorly resourced suppliers. Amongst other international retailers, Wesfarmers signed up to a safety accord to help address worker conditions in other countries. On its website, Wesfarmers specifically refers to this accord (Wesfarmers 2015b). The company also “acknowledges that it has an obligation to continuously improve the way it sources products from developing countries” and that it had done this in a number of ways including through the use of auditing. The audit program had the following findings for 2014:
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Figure 41
Source: Wesfarmers (2015b)
Ethical sourcing extends to the issue of animal welfare. The treatment of animals by suppliers themselves is one that Wesfarmers also tries to manage in its ethical sourcing program (Wesfarmers 2015b). But the strategy is not without some difficulties. Varied interest groups impact this issue, as explained by the Coles Supermarket boss, John Durkin, in this video: http://www.abc.net.au/landline/content/2013/s3787667.htm
So, while the management of suppliers on the commercial grounds of price, quality, and efficiency are key, issues of “fairness”, “ethics” and “doing the right thing” are now, therefore, 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
Some say that a retailer requires a unique set of skills in order to not only devise strategy but to implement it. 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. This is shown in Figure 42.
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Figure 42 Coles Value Chain
Source: Wesfarmers (2015a)
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.
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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.
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Figure 44 The relative shares of Cost of Doing Business across retailers
Source: Productivity Commission (2014 p62)
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 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
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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. A good case study of how a retailer needs to build these skills is in Woolworths’ attempt to start up its own home improvement brand, Masters, from scratch in 2011.
It’s been difficult. In fact, it has been a failure. As noted earlier, Woolworths has announced it will close, or sell, the Masters chain in its entirety after losing hundreds of millions of dollars – at least $500m, if not more by the time the exit is complete. (Greenblat 2015b)
As far back as 2013, management admitted that the company failed to grasp the seasonality of hardware: “We didn’t know a lot about the seasonal curves. We didn’t have the right stock in some instances” the then Masters CEO advised analysts. In an announcement to the ASX the company advised that poor results were due to overly optimistic sales budgets, relatively higher wages costs for new store openings and lower margins due to the sales mix. (Greenblat 2013)
At that time, a prediction for the total chain to achieve break even during 2016 was maintained but Woolworths, as is now known, will cease operations. Even the recruitment of Matt Tyson in 2014 – a former executive of the Kingfisher and B&Q home improvement chains in the UK – could not achieve satisfactory results.
Woolworths is not alone when it comes to poor success rates in trying to start-up new businesses. Coles’ former owner, Coles Myer, in response to the imminent entry of US chain Toys R Us lost over $100m on its own start up toys chain, World 4 Kids, before finally abandoning it in the late 1990s. Also, observers note that that the Coles so-called big box liquor chain First Choice is continuing to struggle against Woolworths’ Dan Murphy brand. First Choice was a new brand for Coles and is yet to achieve the success of Dan Murphy. Some have labelled First Choice, Coles’ (and Wesfarmers) “Masters disaster” – one that is still, like Masters, a work in progress (Evans 2015b).
The way that Woolworths hoped to deal with its Masters problems was in the recruitment of top talent – if you don’t have the skills, get them in; buy them. This is what Wesfarmers did with the hiring of Ian McLeod for Coles. Even though Wesfarmers had had huge success with their Bunnings Home improvement brand since its full acquisition of this brand in 1992, and therefore already had a level of retail expertise, the company wasted no time in hiring the best talent to manage the turnaround of the Coles group of brands upon its acquisition in 2007.
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Wesfarmers clearly wanted not only retail skills, but supermarket retail skills. Goyder and the Wesfarmers board scoured the world to finally get the services of Ian McLeod and as is now evident, the ex-Asda supermarket group executive from the UK has been enormously successful. When things don’t work out, it can be tough at the top. Take Woolworths’ recently replaced CEO Grant O’Brien. He was under tremendous pressure to address the competitiveness weaknesses of the supermarket company.
And it’s not just CEOs; boards are also being examined. For both of the major retailers, a lack of retail skill set at the board level has been raised by broking and media analysts. The broking house CSLA has recently stated that there “should be more retail skill set on the [Woolworths] board; that’s the biggest issue as opposed to the length of tenure” (quoted in Mitchell, 2015i).
Even Wesfarmers’ board is under scrutiny. Currently, there is little direct retail experience on the board but chairman Bob Every defends the board structure. He says that there is a divisional board with the appropriate skill set for each of its retail business; it is not simply the main board. And, besides “[we’re] a conglomerate and we’re currently long retail but we haven’t always been and we may not always be” (quoted in Mitchell 2015j).
While particular types of skills like retail experience can be seen as important, the diversity of skills, knowledge and behaviours is increasingly being recognised as a prerequisite for the long term success of any business. This is especially so in respect to gender diversity. Indeed, large fund managers through the Australian Council of Superannuation Investors, have recently announced that they will target ASX200 companies where there are no women directors on the board (Rose 2015).
Wesfarmers has had a gender diversity policy for a number of years and measures its performance on a number of metrics:
Table 4
Source: Wesfarmers 2015g
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The company believes that its policy will help it to achieve a number of objectives (Wesfarmers 2015g):
 Foster an inclusive culture;
 Improve talent management;
 Enhance recruitment practices; and,
 Ensure pay equity.
Wesfarmers’ policy can be found here: https://www.wesfarmers.com.au/investors/corporate-governance.html
WESFARMERS: WHERE TO NOW?
More generally, when it comes to the skills and talents required, the former head of the largest UK supermarket Tesco, Terry Leahy, believes that what is required is that all companies, but particularly retailers, need to understand their customers better – through “big” data. And, to do this “[one] of the keys is to change the decision making structure…to ensure the data drives every decision made in the business…The problem most organisations have is they have data but they have old-style organisations, the data gets trapped down in sales and customer services and market research – it doesn’t drive the discussions at the boardroom table”.
Further, Leahy says, “To some extent, the mix of talent needs to change at board level. They need more data-savvy people and it may be time for the accountants to move over and get some data scientists in charge. And the marketing people need to acquire more skills and become more numerate than literate” (quoted in Mitchell 2015k)
Retail in Australia is going through major change. This is true internationally. The disruption of on-line and data management technologies is being felt everywhere. But Australia has its own dynamics that need to be managed. If Wesfarmers want to maintain their success in this space, it will need to be on top of these.
It’s a small market and Wesfarmers is dominant in a number of these retail markets. Instead of being seen historically as small players (or “farmers”) from Western Australia taking on the big guys in the “east”, Wesfarmers itself is now seen as big. The company has tried to get around this by its new international strategy via the recent Homebase acquisition in the UK but the experience of other major retail groups suggests that international expansion is highly risky.
Tesco of the UK are pulling out of their operations in Korea and has reduced its exposure in China. Its poor experience in the US market with the Fresh n Easy brand shows that starting up in new markets is not, in fact, easy.
And, recent events surrounding supplier arrangements clearly show that while financial management is still key, success also requires a particular set of skills to manage potentially more political and even ethical issues. Being big means that you are in the public eye!
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What about an acquisition in a completely different business? Wesfarmers have done it before, they could do it again. This is what conglomerates do.
Conglomerates can also get things wrong. But one of Wesfarmers’ key cultural principles may help them avoid this. Former CEO and recently appointed chairman, Michael Chaney sums this up: “I’ve always said ego is one of the greatest enemies of shareholder returns”. His advice to CEOs? “Don’t play the big shot – you might antagonise the gods” (Thompson 2014 p222)
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