The class divides shaping Coles new strategy

Steve Cain’s strategy reset for Coles has some modest goals but very big ambition.

Jun 18, 2019
afr

Forget the grocery price war. Coles Group chief executive Steve Cain is hoping on growth by capitalising on the supermarket class war apparently becoming more pronounced in Australia.

Steve Cain’s big strategy balances big changes in Australian society. David Rowe

Well, class war might be a bit strong. But there’s no doubt that a key part of Cain’s new strategy reset, announced on Tuesday, is the recognition that a sort of two-tiered society – or perhaps even a four-tiered society, when you dig into the new Coles world view – is a reality.

Coles says those in the suburbs have had very little wage growth and live with high debt levels. But the top 30 per cent segment of customers (those earning +$100,000 a year) is growing faster than the market.

And after focusing rigidly (and successfully) on lower prices for most of the last decade, Cain makes no secret that Coles wants to win back these more-affluent customers.

So Cain’s strategy sees four store formats being rolled out in new builds and store refurbishments.

For customers in the mid-to-high affluence demographic – think the suburbs somewhere about 15 kilometres from the city – there will a premium offer, with a focus on “foodie” ranges and convenience.

Store format B is aimed at the middle class, medium-affluence customers in the middle ring of the suburbs. This will be the standard Coles format.

Door 3 is for what Coles calls mid-low affluence customers in the outer suburbs. This will be a low cost, self-service model. Coles says these are low-volume stores that are under the most pressure from online. A case of poorer shoppers looking after themselves?

The final option will be fewer in number but deliver greater profitability. The Coles Local format is aimed at Australia’s wealthiest citizens, and will be a premium offer focused on health, (high-margin ranges like vitamins but also a growing range of products for those with allergies and intolerances) fresh food and convenience.

“We’ve got to be very conscious that is a group of customers that we need to target if we are to grow effectively,” Cain told investors, adding there could be a 40 per cent difference in the range between one store format and another.

Coles has, of course, always tailored its offers to some extent. But there is no doubt what Cain calls the “a tale of two cities” in Australian society, which he more politely describes as the split between those chasing value and those who are demanding increased convenience,  is forcing Coles to confront these new demographics in a more deliberate way.

Using data more effectively to tailor the Coles’ offer both in stores and particularly online (where personalisation is possible) will be crucial to boosting sales and cutting costs.

This fragmenting of the market is why Cain has set goals for his new strategy that are – at first glance – rather modest.

Delivering long-term revenue growth at least in line with market growth isn’t going to excite anyone. Increasing capital expenditure to target returns in excess of the cost of capital will be seen by most as business as usual. Targeting strong cash generation and an attractive dividend payout ratio isn’t a goal, it’s a must.

But this is the new reality that Cain and his investors face. Not only is the consumer base splitting, but it’s also moving online, where growth is close to profitless.

So his most important goal – and certainly the one that sent Coles shares 6 per cent higher on Tuesday morning – is slashing $1 billion of costs by 2023.

Cain plans to combat wage costs that are moving ahead of comparable sales growth, and rising energy prices, by using technology to rip costs – and, to no small degree, humans, out of stores and the supply chain.

Part of this is the giant new automated warehouses that Coles will spend a bit under $1 billion to build over the next five years. But there will also be greater of automation of manual tasks in stores, better labour planning tools, technology to reduce stealing and the use of artificial intelligence in how Coles marks prices down.

Supply chain modernisation and automation – including via the deal Coles signed earlier this year with robot-powered online shopping specialist Ocado – will also be crucial to eking out and then expanding profits from online sales.

So if three of the four goals from Cain’s new strategy look modest, the scope of the strategy is actually pretty ambitious.

Over the next five years, Cain must reset Coles’ cost base, modernise its supply chain, transform its store formats and shift its product range such that better-margin private label products increase by a third, to 40 per cent of total sales.

It’s a huge challenge, and one that won’t probably much do more than let Coles hold its position in a market that is changing rapidly, growing less and becoming less profitable.