WOOLWORTHS has been urged to dump grocery price promotions such as Cheap Cheap in favour of deeper cuts to everyday prices and fewer, deeper weekly specials to limit the damage to sales and margins from an impending grocery price war.
As Coles and Woolworths slashed the prices of products such as Cadbury chocolates, Energiser batteries, Kirks soft drinks and Morning Fresh dishwashing liquid by as much as 50 per cent over Easter, analysts warned that the risk of a full-blown price war appeared to be rising.
Woolworths, Coles and Metcash's IGA retailers have increased the depth and frequency of promotions and cut shelf prices on hundreds of food and grocery items since Woolworths flagged plans in February to invest more than $500 million into reducing prices and improving service in supermarkets to protect its market share.
Woolworths chief executive Grant O'Brien has dismissed suggestions the price cuts could trigger an all-out price war similar to that in Britain, where margins at the big four supermarket chains have fallen by 200 points, or 50pc, in three years.
However, in a new report, UBS said the risk of a price war was growing, pointing out that Woolworths' $500 million price investment was "well ahead of the planned investment by UK supermarkets", while Coles had cut everyday prices on a large range of core products, including sugar, cream and tuna, in the past few weeks.
"Historically, Australian supermarkets have been engaged in a marketing war," UBS analysts Ben Gilbert and Craig Stafford said. "However, the step up in focus on price and material slowing in Woolworths' performance suggest a price war is brewing, similar to those (overseas)."
UBS believes Woolworths' price cuts will trigger a competitive reaction from Coles, Aldi and Metcash's IGA retailers and the impact on industry-wide profitability will be "material", knocking total grocery market growth back to about four per cent rather than 5.5pc and reducing profit margins across the sector.
After analysing grocery price wars in the United States, Britain and the Netherlands over the past decade, UBS said there were ways to minimise the fallout while regaining market share.
The investment bank has urged Woolworths to follow the example of Dutch retailer Albert Heijn, which cut prices by up to 30pc on more than 1000 product lines in 2003 to overcome perceptions its prices were too high.
While Albert Heijn's like-for-like sales dropped two per cent and margins fell 115 basis points over the next two years, sales growth rebounded to between one and eight per cent over the next four years and margins recovered by 140 basis points to reach 7.2pc by 2007.
Albert Heijn, which is part of the Ahold Group, emerged in much better shape than British retailers Tesco, Sainsbury and ASDA, which have been embroiled in a price war with discounters Aldi and Lidl for the past two years.
The Dutch chain also fared better than US retailers Safeway and Kroger, which slashed prices in the early 2000s to compete better with Wal-Mart.
UBS said Woolworths needed to reduce everyday shelf prices more aggressively, especially on products that drive foot traffic, and cut the number of products on promotion to about 20pc of sales (from 40pc currently), while making promotional price cuts deeper on 'hero' products for greater impact.
This strategy, which is akin to that adopted by Coles last October, would reduce labour costs, smooth supply chain flows and generate savings to invest elsewhere, while giving customers greater confidence in Woolworths' prices.
Woolworths also needed to improve communication, with simpler marketing campaigns involving fewer products and clearer messages, UBS said. And rather than being reactive and playing catch-up with Coles and Aldi, Woolworths should be proactive by leveraging data to understand the market better and invest in price in the right categories at the right time.
Metcash and IGA retailers would need to invest $130 million to $190 million to match Woolworths and Coles on price, but did not have the funds to do so and would be better off focusing on differentiation rather than price, UBS said.
"If Woolworths underwent an Albert Heijn scenario, like-for-like (sales) would turn negative in the first year, before rebounding strongly," it said. "Margins would rebase materially (by 100 basis points) in the first year of the price war and continue to a lesser extent (25 points) over the second and third years, but EBIT (earnings before interest and tax) margins would recover very strongly over the next few years."
Woolworths will release the findings of a supermarket strategic review and provide more detail on its price investment plans at an investor day in May.
Woolworths' shares have fallen 15pc since the price investment was announced in February and short interest has risen to a record seven per cent, suggesting the share price is likely to fall further. Metcash shares have fallen by six per cent and Wesfarmers shares by four per cent.