Woolworths is going to have to cut deeply into shelf prices and its profit margins

Marianna Massey/Getty Images for Woolworths

The old, cosy world of high profit margins and big sales volumes are gone for Woolworths.

The supermarket group will need to cut its profit margins so it can bring down prices, attract customers back and regain market share lost to cheaper competitors.

Today’s departure of CEO Grant O’Brien and news that profits are flatlining are indications of a changing world for big supermarkets.

“Woolworths had it very cosy for a long time,” Gareth James, senior equities analyst at Morningstar, told Business Insider.

“The discounters weren’t here and Coles wasn’t doing well. Aldi and Costco are now in Australia and they are committed to growing. I don’t think they will destroy Woolworths like Tesco in the UK. They are different markets. But they are in a more competitive market and Woolworths is adjusting to that. A new CEO could be extremely helpful.”

Aldi has grabbed about 10% of the supermarket business in the population-rich eastern Melbourne to Brisbane corridor.

And it’s all about price. Choice released a survey this month showing that Aldi was up to 25% cheaper than Woolworths and its main rival, Coles.

According to Deutsche Bank, Woolworth’s problems are also about the number of goods available to customers. Fewer items on the shelves means less choice.

“The key driver of the recent sales weakness has been a reduction in items per customer. Poor on-shelf availability clearly could have been a factor in this. Some of the reinvestment will be made in this area,” wrote sector analyst Michael Simotas in March.

And he forecast that Woolworths could be heading into a period of sharp deflation of grocery prices, low sales growth and declining profitability.

A lot of the problem lies in turning around perceptions the Morningstar believes.

“I think Woolworths has been be suffering from the perception that they are slightly more expensive,” says James. “That’s a pretty bad mistake to make in supermarket retailing because shoppers are very price sensitive.”

Many products, especially those home brand style plain label goods, are commoditised. Shoppers just pick up the cheapest. They’re not buying on brand or a perceived quality.

The key to the future for Woolworths are the profit margins.

“The groceries are the largest part of the business and the biggest challenge,” James says. “Woolworths has made high profit margins in recent years. That is going to have to fall in order to get revenue going again and the question is by how much are they going to have to fall by?”

Part of the state strategy by Woolworths is to: “Neutralise Coles and contain Aldi on pricing.”

But, as the outgoing CEO O’Brien said today, the process will take three years and is best see through by a new leader.

Part of the plan is to have a leaner cost base so that prices can be kept down. This is why about 1,200 jobs, many of them back office and non customer facing, are being stripped from the business.

Woolworths says: “We won’t win on price alone – we will neutralise on price but get customers to put us first through experience, freshness and range.”

Here’s the three year plan which aims to establish a deep connection to customers via lower prices, better services (both in store and online), fresher products, a revamped rewards scheme and exclusive brands:

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