Executive Summary
A modern supermarket represents a significant investment (approximately $10M) and it is only natural to site these investments in large population areas because more people equals more business and a faster return on investment.
However, a new supermarket entrant faces significant and co-ordinated competition from Woolworths, Coles and Aldi which have substantial competitive capability from their store numbers (reach), their concentration in key locations (depth) and uniformity in product, price and promotion (co-ordination).
The critical success factor for a new supermarket is to choose their sites wisely. Despite their competitions reach, depth, co-ordination and a fight for a share of the market is inevitable, locations exist that offer a greater likelihood for a return on investment in a more reasonable time than others.
Discussion
There has been a lot of media attention on the imminent launch of Lidl, Kaufland and Amazon into the Australian market. I assume Australia is attractive to these Retailers because of the extraordinary earnings Woolworths and Coles are able to extract, which put them amongst the most profitable retailers in the world. I’m sure these Retailers (the new entrants) are confident their business model can match or better the competitive dimensions of product range and price to attract consumers. However, I wonder if they have given detailed consideration to location?
We always assume Australia has abundant space and finding a retail location isn’t a problem. But it is, and it’s probably going to be the single greatest barrier to entry for these new retailers. Let me explain why.
I read an article a few weeks ago of a Bunnings store being built in a regional area of Australia. What I found intriguing was the investment cost of $46 Million dollars to build and stock one Bunnings Retail Warehouse. That’s a huge investment and it made me wonder what the comparable figure would be for a modern Coles or Woolworths supermarket. Various sources have indicated to me that the fixture costs alone will be in the $5M to $7M and inventory cost could be another $1.5M to $2M and then there are fit-out, leasing, staff, training and utility overheads. Just for sake of argument, let's say the all up cost is in the vicinity of $10M… if anyone has more accurate figures I’d love to hear what the real investment cost is.
The point is, whether the figure is more or less than $10M, the investment is not insignificant and much of this money is a sunk cost even before one customer walks through the door. This is an issue any new retailer faces. It makes sense then to build your store in a location where there are more people because, more people equals more business, right? Yes, but more people equals more competition and this is where Woolworths, Coles and Aldi could have an unassailable advantage.
Let me explain, Australia has a population of approximately 23.7 million people spread over a land mass slightly smaller than the mainland of the United States. However, unlike the United States, our population is highly concentrated with 70% (15 Million) of the population in 606 of our 2,689 postcodes. Further, 14.6M people live within a 100km radius of our major capital cities.
Let’s assume you have $10M spare and you want to build a supermarket. Let’s subscribe to the theory that more people should equal more business, where would you build your store? Top of the list is Toowoomba in Queensland with 107,280 people, so let’s build it and they will come. Not so fast, in that area there are 16 other supermarkets consisting of 5 Woolworths, 5 Coles, 3 Aldi and 3 IGA’s. Let’s assume they are all equally competitive (which they aren’t) and the population is evenly split between the stores. This means the Population/Store (P/S) ratio is 6,705 people per store and if you build your store in this location the P/S ratio would reduce further to 6,310 P/S.
Let me state that my involvement has always been as a supplier to retailers so, I couldn’t be sure whether 6,310P/S is good or bad. However, I do know that the Food and Grocery sector of the economy is worth $105B, which calculates to earnings per head of population as $4,427. If I make further bold assumptions that the average GP for a store is 30% and Cost of Operations (COO) for a Kaufland or a Lidl is in the same range as a Coles or Woolworths at 20% then the EBIT is $427 per head of population, which means the payback period would be 3 Years and 7 Months (if GP% and COO are accurate). However, to highlight the investment/payback sensitivity if I were more pessimistic and suggest that the GP of 30% may be overly generous and reduced it to 25% because of intense price competition (and how unlikely is that) then the payback period increases to over 7 years.
Therein lies the issue for Kaufland, Lidl and any other new retailer entering the Australian market. Any entrant choosing a retail site, that has a substantial population base, not only faces significant numbers of competitors but multiples of the largest competitors (Woolworths, Coles and Aldi) in the same area.
You may say, so what. Competition is competition, it’s their store versus the rest and may the best business strategy win. But it is not, and taking Toowoomba as the example, it’s 1 versus 5 Woolworths, 5 Coles and 3 Aldi each with their unified and competitive range and each with their co-ordinated and systematic promotional schedules and customer loyalty schemes. The chances of making any business head way in this type of environment are remote.
However, it's not all doom for these new entrants, although Toowoomba is highlighted as the epitome of the issue, it is highlighting that a new entrant must choose their battles wisely. “Charging for the Guns”, is a strategy but it is not likely to be successful. Business Intelligence systems will indicate there are over 600 other locations in Australia with higher P/S ratios due to greater population density or fewer competitors than Toowoomba.
Sophisticated market models like those maintained by Market Grunt can highlight those areas that offer a better return as well as the nature of the competition for areas in Australia. If you are a retailer wanting to grow your business, it may be worthwhile discussing what insights such systems can give you. For further information please PM me or go to the Market Grunt website for more details on our market and category models.