Woolworths aims to grow its market share in clothing and food aggressively. Stafford Thomas looks at how it plans to scale new heights.
For over eight decades Woolworths has set the standard for quality in SA's clothing and food retail sectors. But in terms of scale, it has been in the shadow of its major competitors. That is fast changing. Woolworths is now reaching new heights under the leadership of Ian Moir, appointed MD of retail in January 2010 and group CEO in November that year.
Moir came with a formidable record as the man who had rescued Woolworths' once-ailing Australian clothing subsidiary, Country Road. His challenge as group CEO was to unlock the full potential of the Woolworths brand and set the retailer on a new growth path.
Moir tackled the challenge head-on and by March 2010 had the go-ahead to pursue his strategic plan. Though the strategy has brought sweeping changes, Woolworths has remained unswervingly focused on its core market: the upper-income 8-10 LSM (living standard measure) consumer segment. "We will never try to be anything else but LSM 8-10-focused," says Moir.
This commitment is well founded. Moir believes one of Woolworths' big competitive advantages lies in the growing affluence of black consumers. "They aspire to the Woolworths brand even more than white consumers," says Moir.
Moir predicts the LSM 8-10 income segment will grow at 5% annually over the next three years and 92% of the increase will comprise black consumers. In Woolworths' clothing division there is already a 50/50 split between black and white customers, he says.
There is another sound reason for focusing on that niche. "There is less competition in our segment," says Moir. "Everyone is rushing into the mid-market [LSM 5-7] segment." With Walmart-owned Massmart added to the rush, he predicts competition in the mid-market segment will become "very fierce".
Moir's strategy is now well advanced, having begun with a thrust to drive costs down and lift profitability. As part of this strategy Woolworths acquired 59 of its 74 franchised stores at a cost of R701m. "It was a good move," says Moir. "It has given us greater control over our brand and improved profitability." The remaining 16 franchises will be acquired as franchise agreements expire.
In the year to June 2012 conversions added R530m in sales. At pretax profit level, a net R119m was added - 21% of the group's total pretax profit increase for the year.
The results of Moir's strategy so far speak for themselves. In the retailer's three financial years to June 2012 headline earnings per share (HEPS) grew a total of 142%, well over double the 58% total rise achieved in the retail boom years of 2004 to 2007.
Another indicator of success, return on equity (RoE), lifted from 39,4% in 2009/2010 to 47,1% in 2011/2012. This puts it on par with Mr Price's 47,2% and ahead of Truworths' 41,1%, Shoprite's 32% and The Foschini Group's 27% in their most recent financial years.
"To sum it up, we are a much slicker business than we used to be," says Moir. Slickness also shows in operating margins across the group.
In the food division, operating margin has been ramped up over the past two financial years from 3,6% to 5,8%, a level fractionally behind the record 5,9% achieved by Shoprite's SA food retail division in the year to June 2012. "Our target margin is 6%," says Moir. "It's a good margin by any standard worldwide."
Woolworths' clothing division's operating margin has also raced ahead over the past two financial years, rising from 10,4% to 16,7%. It is a margin Moir originally aimed to reach in 2014 and the highest ever achieved by an SA cash clothing retailer.
"We have increased our clothing operating margin target to 18%," says Moir. "Thanks to our improved supply chain we could get more margin but we would rather give better value to our customers. It is a Woolies tradition."
Since 2010 Woolworths' R9,6bn annual sales in its clothing division has undergone sweeping change, particularly in procurement, where foreign suppliers now play a far bigger role. "Our sourcing structure has changed significantly," says Brett Kaplan, group director, clothing & general merchandise buying. "It has resulted in big increases in margins and product quality."
Woolworths has not turned its back on SA suppliers completely and retains strong ties with manufacturers such as Seardel and Peter Blond. "We would like to work more with local suppliers," says Moir, "but can't get enough local suppliers to reliably give us what we want."
One of Woolworths' requirements is faster response times in a competitive fashion world where speed to market is the differentiator. "In the past three years we have reduced lead times by two months," says Moir. This provides Woolworths with more flexibility to respond to customer demand for specific fashion items during a season. Moir says only 60% of purchase orders are now placed before a season opens.
Woolworths, explains Kaplan, has segmented its clothing procurement into four regions, of which one comprises SA, Lesotho and Swaziland. "We procure some basic clothing and some fashion items from suppliers in the region."
Mauritius and Madagascar form another region where Kaplan says "world-class" producers have proved capable of supplying items such as knitwear on lead times as short as six weeks. Another plus is that goods from the region are imported into SA duty-free.
India and Bangladesh form a third procurement region. "They are good at producing certain items," says Kaplan. "For example, we buy school wear and men's formal shirts from suppliers in Bangladesh."
Unsurprisingly, China is the heavyweight region in the Woolworths supply chain. "Chinese suppliers meet our quality standards and are completely reliable," says Moir. When it comes to efficiency, says Kaplan, "China is the Switzerland of the East."
To co-ordinate its relationship with Chinese suppliers, Woolworths opened an office in Shanghai in 2011. "We have 22 people in the office working closely with suppliers on quality control and increasing speed to market," says Kaplan. "We also do three-year planning with suppliers."
Additional costs have been taken out of the supply chain by cutting out importers in SA and agents in China previously used to procure products, says Kaplan. Woolworths, he adds, is focusing on larger suppliers and has terminated more than 100 relationships with smaller suppliers over the past year.
Contracts for specific clothing items are allocated to suppliers best suited to produce them - a move, Kaplan says, that has helped improve quality. "Our product return rate [to producers] because of unacceptable quality has fallen from 0,92% to 0,22%."
Investors who have lifted Woolworths' share price almost 300% since November 2009 are now backing Moir to deliver on the second thrust of his strategy, which calls for aggressive market-share growth.
Moir's targets are ambitious. "In the clothing division we will grow trading area by 7%-8% annually over the next three years [to June 2015]." In total this expansion aims to add 105000m² (27%) of trading space. This will come through 56 new stores and expansion of many of the existing 82 standalone clothing stores, 24 Country Road stores and 171 full-line (clothing and food) stores.
Moir believes Woolworths is well positioned to take on the big fashion retailers at their own game. "Our fashion is now as good as anyone else's," he says.
The revamp of Woolworths' supply chain has greatly enhanced its competitiveness in the fashion space, says Kaplan. "We are launching a new fashion product every two weeks. Because customers tend to visit us two to three times a month, it is vital that there is a constant flow of new fashion items."
Woolworths is also keen to improve its offerings to older customers. "The classic customer is our heartland," says Kaplan. "No other clothing retailer really serves this market sector."
Kaplan says another Woolworths strength in serving a diverse customer base is its "nine box grid" approach to product offerings. The range of products offered is designed to match customers' lifestyle profiles and their target price ranges. Strong branding is used to provide customers with a clear understanding of product differentiation. In some instances a "shop-in-shop" approach is used for brands such as Country Road and Trenery.
Woolworths' loyalty programme plays an important role in optimising customer segmentation. "Through the loyalty programme we can now track the buying patterns of two-thirds of our customers," says Kaplan. "This also enables us to undertake focused direct marketing to specific customers in six distinct groups."
The loyalty programme is playing a role in Woolworths' growth strategy. "Customers love [it] because they get instant discounts at the till," says Kaplan.
But Woolworths is not resting on its laurels. "We must provide consumers with a compelling reason to shop at Woolworths," says Kaplan. "We are already known for our quality and are building on this through the introduction of innovative products."
Highly successful innovations, says Kaplan, include Heat Generation, winter clothing made from a special lightweight heat-sensitive fabric. Another big hit is Magic, a range of clothing designed to assist women conceal unwanted bulges.
Woolworths' ambitious growth strategy in clothing is matched by objectives in its R15bn annual sales food division. "We aim to become a far bigger player in the food sector," says food division MD Zyda Rylands. "I believe there is massive upside potential."
The challenge is a big one. "We have always been a big, small food store business with a focus on convenience," says Rylands. "We are now getting into the ring with the big guys."
Woolworths is now armed with 366 food stores - 152 standalone, 171 full-line and 42 Woolworths Food Stop convenience stores at Engen filling stations. But they are generally small stores. The average trading area, excluding Food Stops, stood at only 484m² in June 2012.
"Limited space does not allow us to provide a full choice of products," says Rylands. This will change with an expansion programme in which existing stores will be enlarged to accommodate wider aisles and a broader product range and the opening of new, large supermarkets. "We will add 49000m² [31%] of trading space over the next three years," says Rylands.
Moir sums up the goal: "We want our customers to shift from shopping baskets to trolleys."
In parallel with its expansion, Woolworths is ramping up the range of food products it offers, particularly groceries and long-life products. An additional 1700 SKUs (stock-keeping units) have been added, bringing the total to about 7500 with a further 1000-1500 to come, says Moir. To do this Woolworths is introducing more branded products to supplement its private-label line-up. Private-label products still make up about 90% of Woolworths' food sales but this will "fall a bit", says Moir.
A key factor in the success or otherwise of Woolworths' growth objectives is price competitiveness. Rylands believes Woolworths is succeeding. "We do a price comparison every week of our basket compared with those of competitors and find the difference over 12 months is under 1%," she says.
Woolworths made its first definitive move into the supermarket space in April with the opening of its 2440m² Woolworths Nicolway store in Bryanston, Johannesburg. A further nine food stores on the same scale are in the pipeline and full-line stores of more than 9000m² are also envisaged.
"As we get bigger, we won't lose sight of who we are and our brand values," says Rylands. "We want to have the mind of a supermarket and the soul of a deli."
The deli concept is the "real point of differentiation" between Woolworths and its competitors, says Rylands. Another important differentiator, she says, is product mix. "About 70% of our business is in fresh products, compared with a norm of about 30% for food retailers."
Woolworths' strength in the fresh produce segment has been built on strict disciplines in its cold chain distribution network. If a fresh produce delivery truck arrives at a store and its load bay temperature is not within strict limits, the load goes back, says Rylands. "That's a Woolworths tradition," she stresses. "We are also paranoid about sell-by dates."
Nor will Woolworths compromise on its standards with branded products, says Rylands. For example, products containing tartrazine or MSG will never be acceptable.
Despite introduction of branded products, she says, the focus remains on building Woolworths' private-label range. The close relationship Woolworths has with private-label suppliers allows Woolworths to control quality better than any other food retailer, she asserts.
"We have an amazing relationship with our suppliers and work closely with them in planning production and developing new products," she says. "Some have been with us for 75 years and we see them as partners. We are almost a fully vertically integrated group."
Moir says Woolworths accounts for the total production of many of its suppliers. "They are prepared to invest to accommodate our growth strategy," he says.
Woolworths itself will have to increase distribution capacity to meet its ambitious growth objectives. At present the group's three central distribution depots in Midrand, Durban and Cape Town are handling just under 90m cases annually, says Sam Ngumeni, the group director responsible for supply chain, logistics, IT, human resources and transformation. "On current growth projections, existing capacity will be fully utilised in two years," he says. "Expansion planning will begin in February next year."
Group finance director Norman Thomson says Woolworths is in a strong position to fund expansion and retain its low dividend cover of around 1,4 times headline EPS. "Our cash model positions us to fund store, distribution and systems expansion out of cash flow," says Thomson. "About two-thirds of after-tax profit is paid as a dividend and the balance plus depreciation gives us well over R1bn a year for capital expenditure."
Woolworths' expansion plans are not limited to SA. The retailer is eyeing the rest of Africa, where it operates in 12 countries through 61 stores. Its focus on the rest of the continent is on clothing. "For us the biggest challenge in Africa is to get sufficient fresh produce meeting our standards," says Rylands. "But as Africa develops, opportunities will come."
In the race for Africa, Woolworths is slightly behind Mr Price, which operates 75 stores in 13 countries, but well ahead of Truworths, with 17 franchise stores in eight countries. Of The Foschini Group's 87 stores in five African countries, 58 are in Namibia.
Moir believes the number of Woolworths stores in Africa could grow to around 180 within seven years. Africa's contribution to group sales could potentially rise from 3% to 10% over the period, he adds.
A strategy of shifting away from the franchise model towards a joint venture (JV) model is also being pursued, says Moir. Woolworths bought out its Mozambique franchisee in 2011 and more recently franchises in Tanzania, Zambia and Uganda were converted into JVs in which Woolworths is the controlling shareholder. In Kenya, a franchise is in the process of being converted into a JV.
Woolworths also re-entered Nigeria in 2011 through the formation of Woolworths Retail Stores Nigeria, a JV with a Nigerian conglomerate Chellarams. Three Woolworths stores have been opened under the JV and a further seven are planned within two years. The long-term target is about 30 stores in total.
Also in Moir's sights is the Woolworths franchise in Botswana. "It is the biggest business we have in Africa and has real critical mass," says Moir. The franchise, he says, has a 50% share of Botswana's clothing market and also operates in Namibia, Ghana and Swaziland.
Looming large on Woolworths' operational screen is Australia, a market it entered in 1998 through the acquisition of an 87,9% stake in Country Road. With 167 stores in Australia and New Zealand, Country Road contributed R3,4bn (12%) of Woolworths' group sales and R172m (6%) of pre tax profit in the year to June 2012.
Country Road's contribution to the group is set to get larger with its acquisition in August of Australian fashion retailer Witchery for A$172m (about R1,57bn). The acquisition will add much-needed scale in Australia's fragmented apparel sector, says Moir.
Country Road's sales will be boosted by A$260m to A$679m by the acquisition, taking its market share to about 6%. This will rank it second behind Premier Retail, which has a market share of about 7%.
Moir believes the deal was perfectly timed and a bargain, executed at a price less than the vendor, Gresham Private Equity, paid for it in 2006. "They were looking to sell in a market in which no-one was buying," says Moir. "We bought it at only five times Ebitda."
He adds: "Witchery is not a broken company. In fact its margins are higher than Country Road's." The deal, he says, will add about 4c (1,5%) to Woolworths' HEPS in the year to June 2013 and further benefits will follow.
Annual cost savings of A$10m are targeted to be extracted from the enlarged Country Road over the next four years. "That is a conservative target," says Moir. "We will also extract more margin out of what is now a larger buying base for the whole Woolworths group."
Moir is upbeat on Australia's growth prospects. "Over the next five years Australia's economy will outperform those of other developed markets."
On Moir's record, few would bet against his judgment. But what does Moir himself see as his biggest success since becoming Woolworths CEO?
"Our most important achievement has been an absolute focus on the customer," says Moir. "It has brought clarity and purpose to the business."
Moir also has high praise for Woolworths' more than 22400 employees. "It is staggering to see what so many of our people do for the company and customers, even in their own time."