In recent years, Wesfarmers Ltd (ASX: WES) and Woolworths Limited (ASX: WOW) have developed a reputation of pushing the boundaries of acceptable conduct in order to turn a profit.
They appear to have become much like the big four banks in this regard, apparently taking the view that it is better to ask forgiveness than permission.
This combined with the difficulties that the Australian Competition and Consumer Commission (ACCC) and other regulatory authorities face when attempting to punish the supermarket majors means breaches often end with voluntary changes and occasionally a token fine.
(You can find out more about recent transgressions by the supermarket majors here, and here)
Fairfax media reported late last week that Coles (owned by Wesfarmers) had finally been found guilty of breaking consumer law by advertising pre-baked bread products as 'freshly baked', and 'baked today'.
Essentially the bread was pre-baked overseas, before being finished in a store oven on the day it was sold, and advertised to consumers as being baked fresh that day. Coles was fined $2.5 million plus costs, roughly a third of the ~$7.28 million in Earnings Before Interest and Tax (EBIT) that Coles earned from the bread products in the three years they were advertised.
While technically not a lie, since the bread was 'baked' (finished) in stores that day, the sales clearly skirt the line of legality and in this case, were found to be on the wrong side of that line.
The real question for shareholders should be: 'Why are Woolworths and Coles routinely engaging in this kind of conduct?'
The answer is not simple, and could be composed of many reasons:
- The law is not always clear
Like with the 'baked fresh' example above, there are grey areas that can be stumbled into – sometimes unwittingly, sometimes not – by companies attempting to follow the law.
- Lawsuits are the cost of doing business
This is a disturbing view, and is an idea that has been repeatedly attacked by ACCC Chairman Rod Sims in his public statements.
With the ACCC lobbying to drastically increase the penalties for breaches, executives that hold this viewpoint could become a major liability for Woolworths and Coles in the future.
- It's becoming increasingly difficult to generate growth
It's difficult to find an explanation for the above bread situation that doesn't involve profits. On one hand, Coles achieved the cost and possible tax savings of baking bread overseas, while maintaining the sales driven by consumers chasing fresh bread.
Readers might then speculate that if cost savings were achievable in a more reasonable manner, grocery stores wouldn't have to push the limits so aggressively to achieve them.
While I still like Woolworths and Wesfarmers as investment ideas, a continued commitment to pushing legal boundaries has me wondering if both companies could be brewing up bigger problems for their future.
