No let-up in retail pressure

Anyone involved in supply to the grocery trade who is hoping that the intensity in retail competition will soon relax had their hoped dashed last week. The annual financial results of Wesfarmers and the accompanying statements made by the company's chairman Richard Goyder about the road ahead for its subsidiary Coles give a clear indication that price-based competition with Woolworths has a while to run yet. Why focus on Coles? The resurgence by this retailer is the single biggest driver of the intensity in competition at present.

Some could expect to see the bottom line of Coles hammered by the effects of 6 months of deep-discounts under the "Down Down" campaign, which the company has valued at about $800million of “consumer savings”. But the grocery division profits actually grew more than $200m or more than 21% in the full year.

A couple of months back, the retailer pointed to a number of compensating measures that it said would offset the impact of discounts. These included a reduction in waste and costs of physically moving products through its system, but the biggest boost to the bottom line has been the growth in sales over the full year. The food business grew sales by $1.5billion over the full year. About a quarter of this goes straight to the bottom line helping pull the overall result up.

Coles underlying business is growing faster than its bigger rival Woolworths, and it has turned the tables on its competitor in leading out new initiatives. In terms of an overall grocery retail contest between the big two, the clawback by Coles against its bigger rival has some way to go. Various other measures of retail performance - sales from floor areas, margins on sales, cost of doing business etc – each still have Woolworths well ahead, with a slowly closing gap.

Wesfarmers will be happier with this result, but it knows the contest can’t slow, as any retail chain can’t rest on its laurels when retail spending by consumers is as cautious as we’re seeing in 2011. Chairman Goyder indicated the play will get harder as Coles will only dig deeper. With the hunt for value by shoppers expected to remain intense, any retailer is challenged to refresh its appeal to grow customer numbers, and then win more of their business once they are in the store. Coles updated store format is delivering more added sales than the roll-out being made by its rival.

The rivalry will also remain fierce as regime-change continues as work-in-progress at Woolworths, with a new chief now appointed and management team being assembled. This is a reversal of the state of play before and after Wesfarmers took control.

But while outrunning rivals in food retail is one issue for Wesfarmers, the overriding priority is locking-in better returns on investment. Coles has a relatively low return on capital sunk into the business by its parent compared to other Wesfarmers units. Coles uses more than half of Wesfarmers’ capital, producing only 35% of its profits in 2011.

Extended price-based competition - coupled with a high $A, weak consumer spending and rising operating costs - will continue to force revolutionary change in the supply chains of grocery suppliers.