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Are supermarket shareholders well served by the move to home brands?

A recent poll conducted by market research organisation Roy Morgan has produced some interesting findings and could be cause for concern by shareholders in Australia’s three leading supermarket chains Woolworths (ASX: WOW), Wesfarmers (ASX: WES) and Metcash (ASX: MTS).

As has been widely reported over recent years the supermarket chains have not only been squeezing suppliers for better terms but they have also been actively replacing branded goods with home brand alternatives. This practice has been particularly evident amongst the ‘second tier’ brands.

In other words, while the first and second bestselling brands will find a home on the supermarket shelf, the third and fourth most popular brands are more likely to be replaced by a home brand alternative. This strategy which has improved profit for the supermarkets, due to the better profit margin on a home brand product, has meant the disappearance of many popular ‘second tier’ brands.

The findings from the research by Roy Morgan describe a less than pleasing customer environment.  Only 56% and 52% of shoppers at Coles and Woolworths, respectively, said the stores carried the brands they wanted. This was down from a peak in 2011 of 63% and 61% respectively in October 2011. Things were even worse at Metcash-supplied IGA banner stores with just 48% of customers responding that they could find the brands they wanted. The worry for shareholders is that management’s near-term goal of boosting profits may be having a longer term negative effect on customer experience and goodwill towards these supermarket chains.

Wesfarmers has not just expanded the home brand strategy within its Coles supermarket stores either. The retailing conglomerate has also aggressively used the strategy in its Kmart division. The strategy has proved successful, with Kmart’s profitability spiking recently however some analysts have questioned the sustainability of the move.

Woolworths meanwhile has expanded its home brand reach into its liquor stores such as Dan Murphy’s. Utilising its substantial shareholding and supply agreement with Gage Roads Brewing (ASX: GRB) Woolworths has contracted for the production of beer exclusive to its liquor stores.

Foolish takeaway

While in the short-term boosting profit margins via expanding the home brand offering can be beneficial to the bottom line, in the long-term giving customers what they want is often a good policy for producing repeat business. Management at the major supermarket chains need to be careful that they are not being short-sighted in their approach to their customers as otherwise they may run the risk of destroying long-term shareholder value.

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Motley Fool contributor Tim McArthur owns shares in Gage Roads Brewing.

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