Why Woolworths Limited will lose a price war with Coles

Woolworths Limited (ASX:WOW) has more to lose in a price war with Wesfarmers Ltd's (ASX:WES) Coles.

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

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.

Motley Fool Contributor Owen Raszkiewicz does not have a financial interest in any company mentioned. Owen welcomes -- and encourages -- your feedback on Google+, LinkedIn or you can follow him on Twitter @ASXinvest. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »