The Distillery: Woolworths' Lowe point

Like an aging father with no construction experience aspiring to build his own shed in the backyard, there have always been concerns that Woolworths’ foray into hardware retail was, well, maybe not such a good idea.

Now it isn’t just apparent that Woolworths has displayed a stunning lack of ability and understanding in the rollout of its Masters chain with US giant Lowe’s, it will take a special effort to turn this faltering project into something worthy of the retailer’s stable.

Fairfax’s Adele Ferguson begins proceedings this morning by listing off the misjudgements that Woolworths made with its initial foray into hardware retail – sales forecasts, gross margins and costs.

Well gee willikers – they all sound kind of important.

“The challenge for Woolworths is convincing the market that the losses will stop. It said losses would not ‘exceed this year's level’ but that it would break even in 2016, which is in line with its original target. But given the size of the losses this year and next and the number and type of mistakes that were made, the market isn't overflowing with confidence. To put it into perspective, the $157 million loss doesn't include allocated rental costs. The joint venture between Lowe's and Woolworths owns most of the stores, so if the result was lease-adjusted it would blow the loss out to an estimated $200 million on revenue of $529 million. This is equivalent to losing more than 35 cents in the dollar, which is huge. Woolworths has committed to opening 90 Masters stores by the end of 2016. To date it has 31.”

The Australian Financial Review’s Chanticleer columnist Tony Boyd says it would be a mistake to lambast Woolworths for its decision to challenge the dominance in the home hardware market that it enjoys with Bunnings for a few reasons.

If you believe better competition will be better for consumers, the start-up investment is totally justified. Woolworths could have instead thrown billions into a share buyback, or an investment in Asia, when it has identified hardware in its local market as a logical next step. And finally, grog shop Dan Murphy’s is a terrific example of Woolworths’ ability to build a high profile national business.

“Dan Murphy’s was not a start-up. But it has been transformed from a relatively small chain in Melbourne to the premier destination for beer, wine and spirits. However, it is clear from disclosures made yesterday by Melinda Smith, who is director of Masters, that the original Masters business plan lacked the necessary rigour you would expect from the country’s biggest supermarket group. Smith’s honesty about the fundamental mistakes made by Woolworths when setting up the business was disarming.”

Like Boyd, Business Spectator’s Stephen Bartholomeusz is hesitant to declare that Woolworths over-reached with its decision to take on Bunnings, but recalls that at the time the decision was taken, Woolies was smashing Coles in food and liquor. The majestic turnaround led by Ian McLeod that gets so much attention today, had only just begun.

“Strategically, it would have appeared compelling to attack Wesfarmers’ star retail business – the high-margin, high-returning Bunnings – while Wesfarmers appeared vulnerable and undermine its capacity to support the investment in the attempt to revitalise Coles and its sibling brands. The rapid resurgence of Coles, the hockey-stick performance of Kmart under Guy Russo, Woolworths' own complacency and the difficulty of being the second and late entrant into a big box hardware market where Bunnings had already staked out the most attractive sites and developed a highly effective and efficient model meant that the context within which Woolworths developed its strategy has shifted dramatically, as has the general climate for retailers across the board. It hasn’t helped that Bunnings saw it coming and accelerated its own network expansion strategy and refined its offering in the knowledge that the Masters’ format would borrow from Lowe’s offerings in the US.”

Indeed, The Australian’s John Durie builds on this dynamic, by pointing out that Woolworths has played itself into a business where it’s getting smashed after having lost some authority in the supermarkets race.

“The final chapter of the management text book is yet to be written, but the guy with the last laugh right now is Coles's Ian McLeod – he is steadily improving returns while his comrade John Gillam at Bunnings is starving Woolies of oxygen. Woolies' supermarket numbers will now be closely watched to ensure margins are not being inflated to help offset the hardware debacle. Smith confided yesterday that the fact the rollout was slower than expected was not a problem because it gave her more time to fix the problems in the stores she had already installed.”

How then has this business venture gone so badly, asks The Australian’s Blair Speedy? Especially given the fact that Woolworths isn’t operating alone, but with the assistance of a US hardware giant.

“Good thing Woolies has Lowe's on board, a major US home improvement player which, Smith notes, has no fewer than three of its most senior executives on the Masters board and is a constant source of ideas and new products for the business in which it holds a one-third stake. Except the fact that it's in the northern hemisphere means key parts of its strategies aren't applicable here. ‘When it's Christmas time over there it's also winter,’ Smith said. ‘Our Christmas time lines up with spring and Father's Day so it's a different seasonal curve and there's no doubt a heap of opportunities to better capitalise on that. We didn't have the right stock in some instances and we left quite a lot of opportunities on the table.’ Which makes it sound like nobody noticed they were in the southern hemisphere until snowblower sales failed to record their usual Christmas boom.”

Elsewhere, The Australian’s Adam Creighton looks at the difference between using annual earning and net wealth as a means of measuring who is deserving of support from the government.

And finally, The Australian Financial Review’s Matthew Stevens says one of the key issues largely left alone by haulage company Aurizon yesterday during an investor briefing “was the unhappy fact that two of its key coal customers insist that the rail operator is extracting excessive, unearned value from it under-regulated monopoly infrastructure”.