Down, down, profit margins are down

Earlier this month I travelled to Europe and the UK to undertake a detailed assessment of the supermarket sector. These markets are further down the road than Australia in terms of the disruption from discount supermarkets like Aldi, so it is useful for us to analyse the situation there in order to understand how the situation is likely to unfold here in the next few years.

The trip included meetings with Tesco, Jeronimo Martins, Sainsbury, Morrisons, Colgate and DIA. I was also fortunate enough to meet with Archie Norman who has, among other things, been chairman and chief executive of ASDA and was a British MP from 1997-2005. He also advised Wesfarmers on the acquisition of Coles and was instrumental in turning the Coles business around.

The key observation is that once discounters enter a market and gain a foothold, they have profound and structural negative impact on profits for the established players.

Discounters have been repelled in France and Poland – but it involves an aggressive roll-out of new stores and significant cuts in pricing before they gain a toehold. So it essentially results in the same outcome of reduced profits. Australian supermarkets seem to have missed this chance given Aldi already has market share.

The price of groceries has been driven down by competition and a lack of innovation. Once down, it is hard to raise prices again. A lack of innovation is also seeing subdued growth in volumes. An example of innovation in years past is the move from offering one type of tomato to several types of tomato within one store. This is no longer apparent.

Crucially, private label profit pools shrink for all players (think Woolworths “Select”, or Coles “Finest”). This has historically been a strong driver of profits.

Fundamentally, this reinforces a negative view of the structural themes in the Australian supermarket industry over the medium-to-long term. There does seem to be a view among some in the Australian market that profit margins here will recover. This looks doubtful, based on the evidence from Europe.

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