With the Woolworths Limited (ASX: WOW) share price sitting at a price not see since 2006, it's abundantly clear Coles, bought by Wesfarmers Ltd (ASX: WES) in 2007, is winning over shoppers.
Sure, Woolworths' supermarkets were the crown jewel in its portfolio for many years. However, its willingness to gouge consumers for wider margins and extra profits has now come home to roost.
Indeed, the heady days of 7% profit margins within Woolworths' Australian Food, Liquor and Petrol division — compared to the 4% to 5% Coles generates for Wesfarmers — appear done and dusted. Woolworths was one of the most profitable supermarkets in the world.
The bigger they are the harder they fall
A declining profit margin is particularly important for Woolworths because it is the company's primary profit generator and it's a volume business — meaning it's very sensitive to changes in profit margins.
By contrast, coming off a smaller base (in terms of profit margin) the Coles business could continue to generate profit growth until industry margins reach, what economists would call 'equilibrium'.
Moreover, if we factor in consumer perceptions, which play a powerful role in retail, many of us are likely to continue going to Coles and Aldi for some time, even if prices are cheaper at Woolworths.
Rewards without profits
Woolworths recently began trialing its new rewards program, after it decided to cut Qantas Frequent Flyer points from its loyalty program in a bid to cut costs.
Following the launch of the new rewards program, news.com.au published an article entitled: "Shoppers want lower prices, not rewards"
And it's true.
If Woolworths experiences a significant decline in market share as a result of the recent trends, you can bet Woolworths will continue to lower prices — as it has done recently. That's good news for those consumers still shopping at Woolies, but it's bad news for shareholders.
Lower prices equal lower margins and eventually lower profits. Indeed, as any investor or analyst will tell you, the only way to maintain profitability is to lower costs.
That's something Woolworths and Coles have already explored. Private label products and allegedly poor practice with farmers and suppliers have become the norm. Then, automated checkouts and expansions into complementary services like mobile phones, insurance, credit cards and online ordering have been identified as the low hanging fruit. But they aren't going to move the dial significantly. At least not anytime soon.
Foolish takeaway
Consumers have voted with their feet and wallets. More of us are choosing Coles and Aldi. With the perception of being more expensive, Woolworths appears to have just one strategy left. Lowering prices.
If it hasn't already, it risks starting an all-out price war.
