KEY TAKEOUTS

• South Africa’s food retail sector is hugely competitive, with high barriers to entry and low product differentiation.
• By maintaining a formidable economic moat, Shoprite Holdings has thrived amidst fierce competition.
• Its success comes from a clear business model, strong operational expertise and a deep understanding of its market.
• Shoprite’s model captures both those consumers trading down in tough times and those trading up in good times.

In the fast-paced world of retail, where consumer preferences are fickle and competition is fierce, only a few companies consistently outperform their rivals. As American economist and academic Michael Porter once said, “It’s incredibly arrogant for a company to believe that it can deliver the same product that rivals do and do better for very long.”

Africa’s largest food retailer, Shoprite Holdings (Shoprite), is one such anomaly, consistently taking market share from its peers. While many businesses have competitive advantages, only a select few possess what Warren Buffett refers to as a “moat” – the ability to sustain their advantage over time. Shoprite exemplifies endurance in this regard, demonstrating how a company can thrive amidst fierce competition by building and maintaining a formidable economic moat. This continuous reinforcement has been the cornerstone of Shoprite’s success, securing its position as a market leader and delivering sustained returns on invested capital.

The competitive landscape of food retail

South Africa’s food retail sector is notoriously challenging and highly competitive. Within the formal market, key players like Shoprite Holdings, the Pick n Pay Group, the Spar Group and Woolworths Food dominate due to the high barriers to entry. Establishing a physical store network, investing in branding and developing efficient supply chains require significant capital. This limits the number of players in the market and, as such, they collectively control a sizable portion.

While the demand for food tends to be inelastic compared to other product categories, the products and brands offered by food retailers are often similar, if not identical. Given this low product differentiation, price becomes a critical factor in consumer purchasing decisions.

Depending on their store format, retailers tend to differentiate themselves by:

• Enhancing in-store private labels
• Improving food quality through better sourcing and supply chain management
• Offering additional services, like on-demand delivery, to attract convenience-seeking customers.

With South Africa’s economy stagnating and real wage growth remaining low, consumers have become increasingly price-sensitive, frequently hunting for the best deals and cherry-picking bargains. In tough economic times, price takes precedence over quality and convenience, leading consumers to trade down across different formats, brands and product categories. To achieve sustainable long-term market share growth, retailers must go beyond competing on price alone. They need to enhance product selection, improve in-store experiences and introduce innovative sales channels whilst keeping operating costs low – due to the thin margin nature of the business.

A journey through market turbulence

Shoprite’s path to becoming the powerhouse it is today has not always been smooth. Its earnings, and consequently the share price, have historically underperformed relative to peers during two significant periods. During the late 1990s and early 2000s, the food retail sector boomed, experiencing tremendous revenue growth. This prompted management teams to seek expansion beyond South Africa’s borders. This “Out of South Africa” period of expansion saw Woolworths Food venture into Australia, Spar into Ireland and Switzerland, Pick n Pay into Australia, Zimbabwe and Zambia, and Shoprite into Nigeria and Angola. In hindsight, many of these expansions failed to deliver the expected shareholder value, due to a range of reasons, including different competitive dynamics, structural challenges (like hyperinflation) and currency devaluations in these new markets.

For Shoprite, the “Out of South Africa” expansion had several adverse effects:

• Significant capital from its South African operations was invested into these regions, increasing overall capital expenditures.
• The regions often had lower margins due to the mismatch between hard currency cost bases and local currency turnover, leading to margin erosion at a group level.
• Replicating South Africa’s efficient supply chain network abroad proved difficult, complicating working capital management.
• These challenges culminated in a significant erosion of returns on capital.

A strategic shift and investment in core operations

In 2017, and under new management, Shoprite refocused its strategy. A new remuneration policy aligning management incentives with shareholder value creation was put in place. This new policy placed emphasis on long-term returns and free cash flow. Consequently, management shifted its focus back to its more profitable South African operations and reduced exposure to the volatile and unprofitable regions in Africa. The company embarked on a significant capital investment programme aimed at better positioning itself for the future – improving the in-store customer experience, enhancing its supply chain and digitising operations. Though costly, these investments paid off, catalysing into a recovery of shareholder returns and continued growth in market share.

Flywheel effect drives success

Shoprite’s deep understanding of its market and its exceptional execution have allowed it to develop a powerful flywheel effect, akin to that seen in international market leaders like Walmart and Costco.

This effect is driven by two key elements: the clarity of the business model and strategy, and management’s operational expertise.

1. THE BUSINESS MODEL

Shoprite employs a multi-format approach to cater to different living standards measure (LSM) segments, ranging across lower and upper LSMs. Its USave format targets low income LSM 1-5 households, extending the group’s reach into rural areas in South Africa and other frontier markets in Africa. The Shoprite and Checkers formats serve LSM 4-7 and LSM 7-10 groups, respectively.

By segmenting its target markets, Shoprite has successfully:

• Tailored its approach to each customer segment, offering a unique, differentiated product range and in-store experience.
• Captured consumers who change behaviour and trade down in tough economic times or trade up during periods of prosperity.

2. MANAGEMENT’S OPERATIONAL EXPERTISE

In the rapidly evolving food retail space, where consumer preferences and behaviours are constantly changing, the ability to anticipate and adapt is crucial. Shoprite has consistently stayed ahead of the curve by consistently improving its product offerings and retail strategies.

Key aspects of Shoprite’s management strategy include:

• Strengthening its offering by expanding the convenience store formats and on-demand home delivery, Sixty60.
• Increasing private label penetration, which boosts gross profit margins and allows for strategic price investments.
• Deepening customer knowledge and facilitating effective, tailored marketing through the Xtra Savings loyalty programme.
• Growing wallet share among higher LSM groups by focusing on fresh and convenient meal offerings through the Checkers FreshX formats.

The refocus in 2017 marked a period of substantial investment in the company’s operations, particularly in IT, logistics and supply chain management. These investments enabled Shoprite to optimise inventory, accurately forecast product demand and ensure shelf availability. Recognising the growing demand for convenience, Shoprite also expanded its online presence and enhanced its e-commerce capabilities even before the Covid-19 pandemic cemented a change in consumer behaviour.

This strategic focus on “precision retailing” has enabled Shoprite to achieve significant economies of scale, reinforcing its competitive edge. As the largest route-to-market for food manufacturers in the region, Shoprite’s bargaining power has led to lower unit production costs. The company often leverages this advantage to offer consumer discounts, driving higher volumes and further reinforcing its economies of scale.

By consistently protecting and expanding its moat, Shoprite has been able to steadfastly generate higher returns on its invested capital. Over time, these higher returns on capital have fuelled growth and profitability, ultimately leading to increased total shareholder returns. Over the past five years, Shoprite has been among the top five positive attributors to performance in our client portfolios.