There’ll Be No Winners From A Supermarket Price War

TescoNews emerged this week that Wm. Morrison (LSE: MRW) is to slash the prices of a further 135 products across its stores. Furthermore, the company has said that this will not be the last time it makes wholesale reductions to its prices, with the move clearly being an attempt to improve its stalling top line, even though it could hurt the bottom line.

The news comes after Tesco (LSE: TSCO) announced that its focus on cutting prices was helping to improve the customer experience. Meanwhile, J Sainsbury (LSE: SBRY) struck a deal with Danish discount retailer, Netto, to return the brand to the UK in a joint venture.

However, a return to price competition will mean no winners. Here’s why.

A Race To The Bottom

Over the last few years there has been a two-speed supermarket sector in the UK. In ‘top gear’ have been discount retailers such as Aldi that have specialised in offering cheap, own-branded alternatives to branded products and which have enjoyed considerable success. Likewise, higher-end supermarkets such as Waitrose have succeeded in offering higher quality products to a customer base that is less concerned with price.

However, stuck in ‘neutral’ are the supermarkets in-between, namely Sainsbury’s, Morrisons and Tesco. They have been squeezed on price from below and on quality from above, meaning they occupy an unattractive (at present) middle ground.

Their response has been to cut prices. However, a glance at any of their recent updates shows that the strategy is simply not working. Certainly, Sainsbury’s strategy seems to be more logical than that of Tesco or Morrisons, since it has cut the price of branded goods to entice shoppers in and then attempts to sell higher margin own-branded goods to them. However, Tesco and Morrisons appear to be slashing the price of everything. This means margins will continue to be eroded in a race to the bottom.

A Focus On Differentiation

Aldi has been successful in giving shoppers what they want: low prices. However, it’s managed to differentiate itself from other supermarkets through a focus on selling own-brand goods and emphasising their price and quality versus branded equivalents. To suggest Aldi is just cheap is inaccurate, and for Tesco and Wm. Morrison in particular to try and win back customers by just being cheap appears to be a road to nowhere. They must differentiate and add value, as well as remain competitive on price, in order to convince shoppers to return.

Looking Ahead

Sainsbury’s decision to undertake a joint venture with Netto could help it to leave the ‘squeezed’ middle, by moving the Sainsbury’s brand up to compete directly with Waitrose and leaving the Netto brand to focus on price and differentiation. However, Morrisons and Tesco appear to be engaged in a tit-for-tat battle that could go on for many months. Trading on P/Es of 11.1 (Tesco), 14.5 (Morrisons) and 10.7 (J Sainsbury) shows there is long-term value in the sector, but that there could be more volatility before things start to pick up.

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Peter owns shares in Tesco, Wm. Morrison and J Sainsbury. The Motley Fool owns shares in Tesco.