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Investors turning their backs on Woolworths

BusinessDay has published a stinging critique of management decisions at retailer Woolworths (ASX: WOW) that may shed light on how Coles managed to claw back market share. Coles, under the stewardship of Wesfarmers (ASX: WES), which purchased the supermarket and discount department store business in 2007, has instigated an enormous turnaround, which has seen its sales per square metre improve by an estimated 20-25%.

It appears that in late 2008, in response to a reinvigorated Coles, the head of Woolworths’ supermarket division Mr Greg Foran suggested the supermarket business aggressively cut prices. Mr Foran held the view that Wesfarmers had too much debt and that Coles would be forced to follow Woolworths into a price war that Coles would ultimately lose. In the process Coles’ profits would decline, which in turn would put pressure on Wesfarmers and allow Woolworths to maintain the upper hand in the duopoly. However (according to the report) the then-CEO and CFO of Woolworths disregarded Foran’s plan, electing instead to focus on delivering double-digit earnings growth before all else.

The strategic decisions (or perhaps blunders) were summed up in the BusinessDay article as follows:

“That early period following Wesfarmers’ takeover of Coles is seen by industry observers as the defining moment for Woolworths. It is seen as the start of when the Queen Mary lost her way – a period that culminated in last week’s admission by Woolworths that it had misstepped in its foray into the big-box hardware sector.”

While it is too soon to tell whether the foray into hardware via the Masters brand will prove successful or not, given the market share and margins Bunnings enjoys, it is understandable that Woolworths has entered this sector. Woolworths has committed significant capital to the Masters roll-out and management should be judged based upon the return on invested capital which is ultimately achieve. Time will tell.

Foolish takeaway

Coles is certainly ‘back in the game’ and there are lessons in strategy to be learnt. If Woolworths’ management did indeed pursue short-term returns over the chance to significantly strengthen the long-term market position of the supermarket business, then this was undoubtedly a mistake.

The mistake would appear to stem from a myopic aim to maximise near-term profit growth that allowed Coles to steady itself and ultimately reduced Woolworths’ shareholder value over the long term.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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