Is this the big price war we have all been waiting for?

Why is there a war?

The big four have woken up and smelt the coffee. After previously dismissing them as a minor irritant, Asda is obsessed by Aldi and Lidl. Before Christmas it announced a £200m investment to take its pricing closer to the discounters, and in February it revealed it was now 10% more expensive than Aldi and Lidl compared with 20% a year ago.

It also announced a further £100m investment in price for this year on the same day Tesco revealed it was throwing £200m at its pricing, sacrificing some of its famous 5.2% margin However many in the City called for a more aggressive play. Then last week we got it - Morrisons boss Dalton Philips said he was no longer going to take the attack of the discounters lying down and revealed a £1bn investment over the next three year, halving its pre-tax profits for the year ahead to around £350m. This, said analysts, was the start of a price war proper with one suggesting Philips “had got the bazooka out”.

What has happened so far?

For all the talk of heavy artillery, the war has so far got off to a quiet start. Shoppers hitting the supermarkets last weekend in the hope of vastly reduced bills will have been disappointed. Morrisons has only made between 30 to 40 significant permanent price reductions since the start of the year. In January it lowered the price of 14 everyday essentials and has lowered around 20 fruit & veg lines since early February. The latest additions this week were pre-packed broccoli 335g and iceberg lettuce, both down 51p to 49p, and loose courgettes, down 70p per kilo to £1.79.

Shore Capital analyst Clive Black suggests Morrisons had scored something of an own goal in not having made enough reductions already to capitalise on all the free publicity its announcement generated last week. “With such a massive profile, we sense that many free-floating shoppers may have given Morrisons a visit this weekend only to be somewhat underwhelmed,” he argues.

What has the City reaction been?

Morrisons’ shares crashed 12% to a low of 205.2p, but the ripple effects spread much wider. On the day Morrisons’ results were announced, Tesco shares crashed 5% and Sainsbury’s shares slumped 8.5%. Shore Capital declared the sector “uninvestable” while HSBC said it was “in structural decline, with no end in sight”. Fears of a price war soon prompted a supplier sell-off, with those most exposed to the UK hardest hit. Premier Foods’ shares fell 17.5% in a week to 129.5p and even high-flying Greencore fell 11.3%. It has since rallied on news it is to build a sandwich plant on Rhode Island (see p8).

What are suppliers saying?

Some suppliers are similarly underwhelmed by the new strategy outlined by Morrisons. “You can’t out-Aldi Aldi,” said one leading ambient grocery brand. Yet the bigger concern among suppliers is not over growth but margins. “My fear would be that if margins go south then they will look to squeeze suppliers,” he added.

“This is the real deal,” said the boss of another household brand. “There is no doubt retailers will be coming back to the supplier base for money. They always do and we will just see an acceleration of this. Any supplier that isn’t very lean is going to be in the firing line.”

Are the discounters trembling?

You might think that with Walmart’s Asda, Tesco and Morrisons all having them in their crosshairs, Aldi and Lidl would be worried. But the latest Kantar Worldpanel market share figures - with Aldi and Lidl’s sales are up 33.5% and 16.6% for the 12 weeks to 2 March - suggest the momentum won’t change that easily.

“Aldi prides itself on offering low prices every day of the week, meaning our customers don’t have to wait for price cuts to make savings,” says a spokesman. “Aldi is built on true value; offering shoppers the best quality at the best price. This means customers make savings on the products they typically buy each week and that these savings can be made all year round instead of just during a limited promotional period.”

Lidl was equally bullish this week. “We’re focused on our core business model of always providing our customers with the freshest, top-quality products at everyday low prices. Our low-pricing model is what draws new customers into our stores for the first time but it’s the winning combination of great savings and top product quality that keeps them coming back each week,” explains a spokeswoman.

“We have also seen great success from opening stores in particularly affluent areas such as Dorking and Sevenoaks, which shows that Lidl has developed an increasingly broad appeal to the British people, who are realising the incredible value we offer - not just for a limited promotional period but day in, day out.”

What are the discounters doing so right?

If the big four want to offer more competitive prices, like the discounters, they must accept smaller margins, reformulate or negotiate harder with suppliers.

“I’m sure there will be some value engineering by the supermarkets,” says one own-brand supplier. “They will either have to compromise on quality or take a hit on their margins. The discounters are much more realistic with their margin expectations. In some cases discounters are selling our better quality products cheaper than supermarkets are selling our lower-priced, lesser quality products.”

As well as price, Morrisons plans to use its own brand as a key weapon in its fight against the discounters. Despite a major overhaul of its own-label ranges in the last few years, Morrisons has started a further review of its own-brand offer on a category-by-category basis with the aim of reducing the number of SKUs by 20% and making it compete better on price with what the discounters offer.

Own label is also likely to be a big focus for Tesco, Morrisons and Sainsbury’s. However the own-brand supplier warns it will be tough to squeeze private-label suppliers as recent consolidation in the supplier base will make it harder for retailers to switch to alternative, cheaper manufacturers.