Our promotions-driven supermarkets have probably shot themselves in the foot with new research showing how these retailers and their suppliers are pouring $11 billion down the drain every year.
Australia has the most promotions addicted supermarkets in the world after New Zealand with Woolworths Group Ltd (ASX: WOW) and Coles supermarkets, which is owned by Wesfarmers Ltd (ASX: WES), the most aggressive on this front.
But research firm Nielsen has found that promotions are ineffective and generate little to no incremental sales, reported the Australian Financial Review.
This research has bolstered my belief that a second supermarket price war might be inevitable. But before I get into that, the irony from Nielsen's report shouldn't be lost on investors.
You only need to think back a few years ago when Coles and Woolies had engaged in unethical behaviour by forcing suppliers to foot the bill on in-store promotions in a bid to fight off the advance of German discount rival Aldi.
As it turns out, of the $51 billion in annual turnover from promotions, Nielsen found that 48% of these sales would have happened anyway.
Nielsen looked at how much manufacturers and retailers spent on promotions in 22 categories spanning 7,000 items to work out how price sensitive consumers were.
Some products, such as chocolate and pasta, had very elastic demand (meaning demand went up when prices fell); but there were a range of other products where demand was inelastic, such as coffee and bread.
The report found that promotions were focused on products in the second category and that 59% of promotional products did not react to discounts.
This may be why the two major Aussie supermarkets are backing away from using promotions and are investing instead in everyday low prices.
This is essentially the strategy of Aldi and warehouse discounter Costco, and it explains how these offshore rivals may have gotten a better foothold in the local market because of Coles and Woolies promotions-focus in the early years.
Back to my gloomy prediction of a second supermarket war. If promotions are essentially ineffective, Coles, Woolies and independent supermarkets under the Metcash Limited (ASX: MTS) umbrella will have to invest more to lower the regular prices of groceries.
The last price war had been brutal to the margins of our listed supermarkets and the next one won't be any prettier.
The price difference between our incumbents and Aldi is starting to widen again (click here to find out more). This latest research report and the impending arrival of yet another German rival, Kaufland, on our shores means investors should hang on for another potentially wild ride.
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