Money

Woolworths is still in the wilderness

Why making too much money is a problem for Woolworths.

Woolworths has a problem. Well, judging by the closure of Masters, a new advertising brief, and reports that it might shutter some of its upmarket Thomas Dux stores, perhaps more than just one problem. But despite those issues, there's one problem that is at the core of its troubles.

It's a "first class" problem, to be sure, but a problem nonetheless: It makes too much money.

Making too much money is a problem for Woolworths.
Making too much money is a problem for Woolworths. Photo: Glenn Hunt

What? Surely making too much money can never be a problem? Unfortunately, as Woolies shareholders have found out, it can – particularly when the profits it makes are destined to be only temporary.

For almost a decade, Woolworths operated a quasi-monopoly. No, I haven't forgotten about Coles, but the latter's inept management, combined with a slick marketing message and strong sales momentum from Woolies, meant that there was no meaningful competition.

For what seemed like an eternity, Woolies was growing faster than Coles, dropping prices faster than Coles, and – as a direct result – was able to boost its profit margins to far, far above those of its hapless competitor. The degree to which it was both impressive and unsustainable was made clear through Woolies' position atop the totem pole when it came to global grocery margins.

Indeed, according to a UBS report, Woolies' operating margins of 8 per cent were 53 per cent higher than Coles, more than triple the average in the UK and a little less than double those of US grocers. And like Icarus flying too close to the sun, those margins were simply unsustainable.

Under Wesfarmers stewardship, Coles got its act together on pricing, advertising and in-store experience but was prepared to continue to accept lower margins. That left Woolies at a significant structural disadvantage – Coles was prepared to make less, regaining market share in the process.

Failing to learn from the past

Indeed, that was once Woolworths' own strategy. And its abandonment of passing savings back to customers were the seeds of its destruction – even though it delivered higher profits in the short term. Now the chickens have come home to roost, and shareholders have borne the brunt.

To its credit, Woolies seems to have realised the problem: it has provided guidance for lower profit as it "reinvests in price" (read: drops its prices) and has gone back to a clearer marketing message. And, it has been decisive in ridding itself of Masters and revamping its Rewards program.

Unfortunately, not all is well – at least not yet. The company remains without a permanent chief executive, with chairman Gordon Cairns warning the market recently that it might well take longer to find a suitable candidate.

Additionally, the Woolworths Rewards program that replaced the company's old Everyday Rewards program is less a loyalty program than it is an incentive to buy only the products that it wants you to buy – effectively a discount by another name. It doesn't do a great deal to engender loyalty among its existing customers. Indeed, while anecdotal, I've had both a mate and a colleague complain to me about the change.

Foolish takeaway

The good news for Woolworths shareholders is that the company has admitted it has a problem, and arguably the harder step of telling the market that profits will be lower as it seeks to right the ship.

The company desperately needs a new CEO and a deliberate strategy. But most of all it needs to earn and keep customers' loyalty through a better rewards scheme, lower prices and effective marketing campaign. And thus far, it has yet to gain traction on any of the three.

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Scott Phillips is a Motley Fool investment advisor. You can follow Scott on Twitter @TMFScottP. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).