Woolworths Investor Day Special Report

Woolworths
Investor Day
6 May 2015
Special Report
Masters:
an expensive education
Matt Tyson thinks he has developed
the winning formula for Masters —
but we’ve heard this before. Is it more
believable now?
I
n the 45 minutes that Masters Home Improvement
(Masters) managing director Matt Tyson spent on
stage at the Woolworths Investors’ Day on 6 May
2015, he succeeded in providing two portraits of his division. One was what the future of the company might
look like, and the other was, indirectly, a description of
what its past has been.
Looking ahead, its prospects remain mixed. Investment has been reduced to just $600 million over three
years, which, according to Woolworths’ chief financial
officer, David Marr, represents around 50% of the previously allocated budget.
(No details were given on how this affects the co-investment by Masters’ partner, the US-based Lowe’s
home improvement chain.)
In line with this, investment in new store development has also been radically slowed. Woolworths’
2013 annual report stated:
We are committed to securing 150 sites in five years.
Currently there are 120 active sites with around 90
stores planned to open by FY16.
Masters currently has 53 stores in operation. Mr
Tyson predicted 59 stores would be open by the close
of Woolworths’ FY 2014/15. Masters stores set to open
in the near future are located in the following suburbs:
Masters
the short version
The story to date
Masters Home Improvement (Masters) as it was originally conceived was simply unworkable. Aside from
the logistical difficulties of obtaining land on which to
build, and permission to build on that land, the format
of the stores, the range they stocked, and the general
proposition offered to the market were all wrong. As
David Errington of Merrill Lynch has pointed out, every store that was built has simply resulted in worse
performance, and growing costs.
The future story
Masters under the guidance of managing director
Matt Tyson may have found a format that works. This
is best represented by the Rouse Hill store near Sydney in New South Wales. However, Woolworths are
being cautious, and have yet to release any results for
stores operating under the new format.
The story today
So far, only a very limited number of stores operate
under the new format, dubbed by Woolworths Masters 2.0. The real test, as Masters managing director
Matt Tyson has himself stated, is whether when the
new format is retrofitted to older stores it will result
in a near-immediate boost in “sales density” (sales
measured on a per-square-metre basis). Until that is
completely proven, Masters will exist on a substantially geared-down capital expenditure (capex) budget
of just $600 million over the next three years - half of
what was originally budgeted.
The mid-term future
• Bundall, Queensland
• Coffs Harbour, New South Wales
• Albion Park, New South Wales
• Marsden Park, New South Wales
• Landsdale, Western Australia
• Northmead, New South Wales (August)
The ongoing rate of store opening, he said, would
be between four and 10 stores a year. This is a further
slowing, after the announcement in early March 2015
that store growth would be limited to between six and
11 stores a year.
While the Masters exercise has been extraordinarily
expensive and apparently unproductive, its lasting
legacy at Woolworths is likely to be a new capacity to
do the one thing large, well-established companies
find very difficult to do: start new businesses from
scratch. It’s a capability that even very well-managed
conglomerate businesses like Wesfarmers have not
really demonstrated, and could prove crucial to ongoing success in the 2020s.
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Historically, this is down from the18 stores built
during FY 2013/14, the 10 stores set to be completed
in FY 2014/15, and roughly half the growth rate predicted in November 2014.
A more realistic range might be between four and
eight stores. Thus the number of stores open by the
end of FY 2015/16 will likely be around 65.
Woolworths announced Masters had lost a further
$112.2 million at the previous half-year announcement,
a number which exceeded the expectations of many
analysts, with the more pessimistic predicting losses of
around $95 million. Total investment in Masters to date
is thought to exceed over $3 billion.
Masters 2.0
Balanced against these less than perfect numbers is
the promise and hope of what Mr Tyson calls “Masters
2.0”. This a set of initiatives that promise to take the
existing format of the Masters 13,000 square metre
stores and convert it into a store experience with high
per square metre sales in product lines that will return
a better margin than the existing range does.
Mr Tyson identified two major drivers of the change
to 2.0: better space utilisation and better ranging.
These elements are now being deployed with a slightly
different focus than that of the initial design. Where the
original store format was aimed on taking market share
from Bunnings and other competing hardware outlets,
the new stores are aimed at gaining share through
market consolidation. Thus their overall appeal and
approach is targeted much more at customers who
would otherwise be shopping at specialty stores.
At the moment there are four stores (those opened
post-Christmas 2014) that are fully in the new layout.
Another three (including at least one Victorian store)
are being retrofitted with the layout. The five stores due
to be completed in the next six weeks will have the
new layout as well. There is one other store not fully
specified in the new layout as well (Northmead?), making a total of 13, or close to 22% of all the stores.
Masters predicts that 50% of its stores will be in the
new format by the end of FY 2015/16.
Inner space
The core changes made to the space consist of the
following:
• Creation of upfront space for “high visitation” product ranges, such as hardware and garden care.
• What Mr Tyson describes as an intuitive and more
customer-friendly layout.
Masters 2.0 Store Layout
The Masters 2.0 store layout. A new area at the front
of the store provides “high visitation” items, such as
basic hardware, and helps create a “familiar” hardware
experience. Project items are grouped towareds the
back of the store.
• A better front-of-store experience that feels more
like a normal hardware store.
• Better utilisation of space, resulting in an overall
increase in the number of product bays by 20% in
the standard size layout.
• Back-of-store spaces dedicated to “projects”, in-
cluding space for kitchens, bathrooms, flooring and
lighting.
• Expansion of space available for key categories
such as power tools.
One of the main drivers behind the change was that,
as people visit home improvement stores on a low
frequency, the layout needed to be more intuitive. As
Mr Tyson put it:
The home improvement sector the world over is a relatively low-visit sector. It is six or seven visits a year.
The reason I say that is that with the customer only
visiting you six or seven times a year, you better make
sure your layout is intuitive. That is what we’ve tried to
do with Masters 2.0.
Perhaps the greatest achievement of the new layout
has been the creation of additional space by paying
careful attention to how space is utilised.
We’ve taken the same sized box and through some
clever tricks of equipment, aisle widths and space
utilisation, we’ve got circa 20% more racking into the
same space.... We’ve changed the layout as well to
be more intuitive, to be more customer-friendly, so
the front of the store is what you would recognise as
being a hardware store.
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The space gains are shown in this table:
Category
Increase
Garden care
70%
Hardware
40%
Power Tools
30%
Paint
15%
Flooring and tiles
40%
Bathroom
25%
Kitchen
15%
Consolidation
That is part one of the ranging change. Part two
is where things get interesting, because Masters has
actually made a quite acute shift in its competition
strategy.
The label that rests over this new strategy is “consolidation”. The idea of consolidation made its first
public appearance in regard to Masters in Woolworths’
2014 annual report, which stated in part:
The market is fragmented and is in the process of
consolidation as demonstrated by the 42.2% Masters
sales growth in FY14.
Range for the home
The reason behind creating this better use of space is
the need to provide a wider and better-purposed range
of goods. This is not just “more stuff”. Masters has
actually made a sharp turn in its overall strategy.
There are two parts to this strategy.
This reference to consolidation has come back six
months later with considerable force. Part of Mr Tyson’s introduction to his Masters presentation consisted of a comparison of market consolidation in Australia
with that of other markets.
This is the least consolidated market in the developed
world. In Canada 57% of the market is owned by the
top three players. In Australia that percentage would
High visitation
The first part is a shift away from having Masters
lead with its big project-type sales items - kitchens,
bathrooms and so forth. Instead there is a move
towards what Mr Tyson refers to as “high visitation”
categories. This is how he explained the change:
In reality I think our early proposition was probably too
focused on big project categories. And when you see
the opportunity there is in the market, the size of the
grey space there is in those categories, that is probably an understandable thing to have done. But I think
we under-indexed in some of the really high visitation
categories. Categories like garden care or hardware
were probably under-indexed in our early stores, and
we’ve been addressing that.
be 22%.
Consolidation, in this sense, means going after the
marketshare of specialty stores. In order to make that
shift, of course, an entirely new range of products
needs to be offered. It is here where you can see, more
readily than elsewhere, some of the hard work Mr Tyson and his team have been putting into the business.
In the presentation, he called out the following new
range lines:
• Godfrey Hirst (Stainmaster, etc), floor coverings
• Hansgrohe, a high-end European bathroom fitting
supplier
• Uniclic, Europe’s largest manufacturer of hardwood
and engineered flooring
• Henkel, which makes Loctite and a range of other
In other words, Masters will begin stocking and
making readily available those items that people typically “run down to the hardware store” to buy.
In addition, the retailer is going to address a lack of
options in some of its key ranges, again making use of
the extra space it has created:
Because there was space allocation issues, I think
we also had ranging issues as well. We didn’t have a
deep enough range in some of our core categories.
Particularly categories like hardware, garden care,
power tools, as an example. We’ve been working real-
ly had and in a robust way to fix some of those issues.
adhesives
A slide in the presentation added the following suppliers:
• Graham & Brown, wallcoverings
• Bosch Blue, professional tools from Bosch
• Hilti, industrial-level construction power tools
• Englefield, bathroom products such as toilets
• Lofra, an Italian-based maker of stoves
• Vogue Shutters, window coverings
• Redbook Carpets, floor coverings
• Master Lock, security devices
• Triton, precision power tools
In addition to these, the one company Mr Tyson
chose to expand on at some length was the US-based
paint company Sherwin Williams. This an iconic brand,
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which has its origins in immediate post-Civil War
America. It has a great reputation with both amateur
and professional painters.
The expansion that Masters is seeking, based on
these called-out new product ranges, is about both
the home decorator market, but also the more professional, serious tradesperson, seeking to buy serious
tools. Masters already stocks Panasonic power tools,
another serious industrial brand, and the addition of
Hilti and Bosch Blue will bring it into direct competition
with a range of specialist tool retailers.
New competition
The way “consolidation” is now being interpreted
at Masters is that where in the past Masters saw itself
as directly competing with Bunnings, Masters is now
going after the same expansion market that Bunnings
is pursuing.
This is actually quite a brilliant move. Instead of
having to take market share from the most successful
home improvement retailer in Australia, it has moved to
competing for the same expansion market with Bunnings. In that area, Masters’ lack of market definition is
at least neutral, and could in some circumstances work
to its advantage.
The true test
Masters has now added some 5300 new lines to its 2.0
format. Around 2500 are actually new products.
According to Mr Tyson, the results from the 2.0 format change indicate that the new format could be the
solution to Masters problems. He cites improved sales
per square metre, more traffic, and better margins on
the products sold. The new format has also enabled
Masters to experiment with new stocking methodologies, such as store-in-store operations with suppliers
such as Vogue Blinds.
The bulk of those five stores [in the new format] regularly sit in our top five stores. That is very unusual,
actually, it is an unusual pattern. We are seeing higher
sales density, higher footfall, and a better margin driven by mix. But we are not declaring victory. We know
there is an awful lot to do, but we remain encouraged
by these changes.
Matt Tyson speaking at the Investor Day on 6 May 2015
are retro-fitting those three stores I spoke about. The
next six months will give us a clear line of sight as to
how this new proposition is working. We will have a
lot more learning and understanding in six months
time than we have today.
Expensive lessons
The thing is, of course, that there certainly has been
a lot of learning going on — it’s just that it has been
a very expensive set of lessons for Woolworths as a
whole. The question is: has it been worth it?
This was the question that, more or less, the lead
retail analyst for Merrill Lynch - Bank of America, David
Errington posed to Mr Tyson at the end of this presentation. This is what Mr Errington asked:
Matt, I think the area that we’ve been disappointed
with, is that as the stores have rolled out ... the losses
have actually got bigger. Now, on the original thesis,
you loaded the costs up, and then you were sup-
posed to get fractionalisation. But that’s not happening, it is actually that the losses are getting deeper
the more stores you are rolling out. Hence, I think the
rational strategy is to cool it.
But it basically saying that every new store you open
is generating a loss - because the losses are getting
bigger, that’s just a mathematical [fact]. Is that the
case, and if it is so, it means that, fundamentally, the
Understandably, Mr Tyson also remains cautious.
Whatever the positive results from the format in new
stores, the real test of its success will be if it works
when retro-fitted to existing stores.
The next six months are going to be critical for Masters. There is a huge amount of work for us to do.
Right now we’re working on five new 2.0 stores. We
business is, well, broken. Because no matter what
you do, you’re stuck.
The numbers are $200 million loss from 50-odd
stores, that means $4 million EBIT loss per store,
gross margin 30%, you are going to have to increase
the sales density by about $10 million at least, to
break even, and that’s - an impossibility. This busi-
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ness will never break even on those sorts of numbers.
So I just can’t understand what is happening here.
I mean, have you ever seen a situation where it takes
so long to break even on a new business, in your ex-
perience? Because I just can’t see how this business
will ever make money, let alone a decent return on
investment.
(Fractionalisation describes the process where costs per unit
decline as the number of units increase, essentially the cost-efficiency that comes with scale. EBIT refers to earnings before
interest and taxation. Sales density refers to sales per square
metre.)
Mr Tyson replied that he actually had, in his experience, seen home improvement retail stores that took
longer than five years to develop, and that ended up
being profitable. Mr Errington asked him to provide
exact details. “I need to be careful, obviously, because
I worked for the same organisation for 30 years,” Mr
Tyson replied.
I was involved in a number of markets, several
markets where these businesses went on to become
very, very material profit contributors. They weren’t
profitable in their first five years.
It’s not unusual when you are building a big-box home
improvement business like this. I think though that the
challenge is a real challenge. The reason I talk about
the new model and how encouraged I am by what I
am seeing [there], is because I believe that new model
is very important.
So as we add stores we can see a clear line to profit-
ability in those stores. It is too early to put the flag up,
and say “Victory!”. But what we are seeing in those
first three or four stores is encouraging. I believe we
will be able to see that line in those stores.
We have to fix the existing estate, though, and that’s
why I say the test is, can we roll this back to the
existing estate and get the same uplift. I believe it’s
possible because I’ve seen it done before. I’ve been
involved with businesses before where they got to 30,
40 stores, and the model has needed to be signifi-
cantly iterated, but we got there. There is a lot of work
to do, but I believe the prize is worth it.
But I understand your point. I think our challenge
is we never iterated enough in the first three or four
years.
The most telling reference that Mr Tyson did make
to the past came in response to quite an innocuous
question. One analyst asked him to describe some of
the expertise of the recent hires he had brought onboard, and commented that it seemed Masters did not
have that much hardware expertise available in its early
days.
Mr Tyson responded:
As I understand it, the business for its first three or
four years had significant home improvement ex-
perience with support from Lowe’s. As I came into
the business we had plenty of talented people, but I
thought we had gaps in a number of areas.
One of the ones I would call out is experience in
proposition development. So I brought in a guy who
has done nothing else but proposition development
across Kingfisher.
It is a really important skill, but it is a skill that most
businesses don’t have, because, if you are Lowe’s,
you are rolling out roughly the same business model
across the US. So I would call that out as a skill gap in
Masters that we’ve addressed.
This apparently simple answer points directly to the
core problem that Woolworths had in the early days of
developing Masters. It also indicates what Mr Tyson
brought to the company. Very simply, Woolworths did
not have any idea how to go about launching a new
business — and neither did its partner Lowe’s.
What Mr Tyson brought to Masters, right from the
beginning, was something of the language and the
process necessary for a modern startup.
This process has developed in recent years into a
recognisable, set pattern of development. Many of its
features were pioneered by Steve Blank in the business courses he taught at Stanford University and
elsewhere, and later codified in his book The Startup
Owner’s Manual. These principles were also replicated
in Eric Ries’ book The Lean Startup.
At the core of this method is seeing the startup not
as a finished business, but as a method of exploration.
As Mr Blank puts it, “A startup is a temporary organisation in search of a scalable, repeatable, profitable
business model”.
Mr Ries popularised one particular aspect of this
model, which has become known as “the pivot”. It is
the point where a company, pursuing one business
model, comes to realise the real answer lies elsewhere,
and “pivots”, switching its business model to one more
likely to succeed.
Where Masters is today is in the midst of just such
as pivot. Which means it remains far from its ultimate
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solution. As Mr Tyson said when introducing
the idea of Masters 2.0:
For 2.0, please don’t read that evolution is
“it”; that evolution will continue to iterate.
I think that we are probably 80% or more
towards having the right footprint, but there
is still much more work to be done.
Burn rate
The real question Masters has to address in
the immediate future is that of what in startup terms is called its “burn rate”. The burn
rate is the rate at which a startup “burns”
through capital during its quest to find a
suitable business model.
By reducing the capital it draws on, Masters has bought itself some more time to
develop. However, there are worrying signs
that it has not done enough. The company
has a number of circumlocutions that deal
with one of its core problems, which is
simply having too many poor locations for
stores. “Future development area” really
translates in many cases to “location entirely unsuited to a home improvement big-box
store”.
There are some indications that as many
as six of the Masters’ locations would fit
in this category. Even if it is half that, this
would constitute a 5% drag on capital, attention and effort, with little or no prospect
of eventual financial return.
Mr Tyson has correctly identified the
retro-fitting of Masters stores with the new
format as being one of the critical tests the
business must pass. The other critical task
is for the retailer is to develop some method
of disposing with underperforming locations.
Effects of consolidation
For the home improvement retail industry
in general, perhaps the most interesting
element of the Masters current approach is
its apparent focus on issues of consolidation.
As the two graphs on this page illustrate, there is
considerable room for growth in several areas. (Note
that these numbers are approximate, and used for
general illustrative purposes only.)
Of course what needs to be borne is mind is that
while many of these categories are not consolidated in
home improvement, they are consolidated elsewhere.
Carpet is relatively unconsolidated, but appliance sales
are more so. By cross-referencing market share in
home improvement with size of market and the degree
of external consolidation of those markets, a “heat
map” could be constructed indicating where the best
opportunities reside.
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