Wesfarmers’ strategy will entrench retail dominance

Richard Goyder, Wesfarmers Managing Director and Terry Bowen, Wesfarmers Finance Director tour a Target store. The two most interesting business units in the Wesfarmers portfolio are, for very different reasons, Target and Bunnings.

It was instructive that Richard Goyder kicked off today’s Wesfarmers strategy briefing with a defence of a business model that has come under increasing scrutiny and questioning as the group’s retail brands increasingly dominate its performance and its non-retail activities diminish it.

With its coal operations losing money and its industrials division contributing little, there has been a rising debate over whether the conglomerate strategy and structure Wesfarmers has pursued through much of its history remains relevant and value-adding.

Goyder, obviously, believes that when paired with the group’s operating model it does, if the time-horizon for assessing its worth is viewed over ten-year tranches rather than just the past few years.

Even if it wished to pare itself back towards something that could be defined as a retail conglomerate, the current general circumstances in the coal sector and the particular circumstances of Wesfarmers’ Curragh coal business with its hedges and contracts would make it difficult for it to extricate itself from that exposure. Goyder did say that the group continued to look at all options.

If Wesfarmers can deal with the one big trouble spot in its retail portfolio, the badly misfiring Target, and Bunnings is able to make a success of the platform it has bought to launch its home improvement business in the UK, however, the debates about strategy and structure can only intensify.

The two most interesting business units in the Wesfarmers portfolio are, for very different reasons, Target and Bunnings. Target because of the implosion in earnings that has occurred (and which has forced a $1 billion-plus write off of goodwill) and Bunnings because of the risk-reward equation of the UK acquisition it made earlier this year.

In Target, Kmart’s Guy Russo has now been given ultimate authority over both the discount store brands and, it appears, is going to pursue a similar template to the one which turned Kmart from a basket case into a highly-disruptive high-performing brand — and played a role in destabilising Target in the process.

The high-level outline of the strategy provided today indicates that, once the current rationalisation of Target’s legacy inventories, costs and property portfolio is completed, Target’s range will be more concentrated and refreshed, there will be more direct sourcing, less marketing spend, prices will be lowered to drive volume and it will pursue an “everyday low prices” positioning.

In effect, Target will have a similar set of strategies to that employed so successfully at Kmart but at a slightly higher set of quality and price points than Kmart, with Russo sitting above both brands to try to manage the co-ordination and co-operation necessary to both maximise the potential synergies while minimising cannibalisation of one brand by the other.

That challenge of trying to manage brands that have overlapping customer demographics and catchment areas was beyond the old Coles Myer but Russo was able to reinvent Kmart where all previous attempts to successfully redefine that brand had failed.

The Bunnings adventure is somewhat different. It paid what is says was a “headline” price of $658 million to acquire the poorly performing Homebase home improvement business in the UK earlier this year.

Its CEO, John Gillam, says that four months later the thinking behind the acquisition has been validated and that the network supports its model of warehouse merchandising and has the latent capability for Bunnings’ low-cost operating model.

He said he and his team are even more excited now that they are within the business than they had been ahead of the acquisition — even though he said it had been badly managed over the past decade and was one of the most poorly managed businesses in the UK.

The opportunity lay in Homebase’s history of generating far better sales from its stores than it had in recent years and the highly fragmented nature of the UK market, where the two biggest players’ combined market share is lower than Bunnings in Australia. Gillam described the UK market as “wide open”.

For the moment, Bunnings is focused on improving the retail basics of the business, upgrading its staff, investing in the core of what it acquired and developing pilots for the Bunnings warehouse concept that he says would combine the best elements of its Australian business with those local elements it regards as essential to operating in the UK.

The initial pilots should be up and running later this year and their success, Gillam said, is an “absolute pre-cursor” to further investment. Bunnings has said it wants to invest $1bn in Homebase over the next five years but Gillam said his team weren’t going to charge in to the expansion phase of the strategy unless the pilots were demonstrably successful.

In the meantime, the removal of concession stores and non-core products from the network and store closures under its previous ownership mean Homebase’s sales base has been re-based from almost £1.5bn to about £1.2bn, which is opening up space for increases to the breadth and depth of the offer in the stores.

There will be restructuring costs of about £7m (about $14m) this year and Wesfarmers is likely to book goodwill of about £460m ($900m) from the acquisition next financial year.

To help reduce the risk of operating in a new jurisdiction, Bunnings has called on UK retailing legend Archie Norman, who played a major role in the planning and recruitment for the initial turnaround of Coles, as well as former Masters chief executive (and, before that unhappy two-year stint, long time Kingfisher executive) Matt Tyson and Aviva non-executive and former McKinsey consultant Michael Mire to form its initial UK advisory board.

What Gillam and his team envisage is quite a complex and unusual strategy. They plan to renovate Homebase and turn it around — and then shut it down as they launch Bunnings off the platform it provides.

Gillam cites Bunnings’ acquisition of the McEwans hardware business out of receivership in 1993 as the foundation of the Bunnings warehouse business in Victoria as the precedent for what he is trying to achieve in the UK.

“History doesn’t necessarily repeat but we’ve got a lot of experience to draw on,” he said.

Within the Coles supermarket business, John Durkan remains committed to the strategy of continuing to invest in price and service to drive sales growth that has been such a powerful driver of Coles’ growth since its acquisition eight years ago, despite some concern among analysts that the intensity of competition in the sector and its price-based pointy edges has the potential to drain earnings and returns from the entire sector.

Durkan has a turnaround opportunity of his own within his business, with the liquor business a poor business relative to its major rival, Woolworths’ Dan Murphy’s chain.

Two years ago he put a new team into liquor and today he said there were improving sales trends in this business – but that improving profitability remained an “opportunity” as its moves into the final three years of his five-year plan.

Coles doesn’t see its liquor business as a challenger to Dan Murphy’s dominance. It does, however, see it as an opportunity to build a far better and more profitable presence in the sector.