Kaufland, the German hypermarket juggernaut, recently pulled out of the Australian market to concentrate on other markets where it felt it would get a better return on its investment. They left without firing a shot. That is they never actually got around to selling anything. The money lost that they had already sunk? Estimates vary, but the costs sunk in Australia by Schwarz Gruppe, the Kaufland parent company, are thought to range between $435m and $550m. From a job loss perspective, it amounts to over 200.
You could hear the collective sigh of relief from Coles and Woolworths at the news and their share prices lifted considerably as a result. Aldi would have felt relief too. In the Kaufland stable is Lidl, which is Aldi by another name. Only difference? Special Buys Thursday and Sunday! Now that would have been real competition. Imagine the Board room in Germany making the decision to pull out. All that due diligence that said ‘let’s do it’, all the analysis around the non-competitive Australian supermarket market, the money already invested and an important but often overlooked aspect of such decision-making, the ego and reputations of those who originally pushed for the project. That’s why it’s such a fascinating case study of corporate decision making and the psychology of decision-making in general.
Let’s analyse the rationale for Kaufland making the decision to enter the Australian market in the first place. If you want to grow your business then ultimately you need new markets. FMCG has high barriers to entry and establishing supply chains and supplier arrangements is complex. Getting the quality and cost equation right is essential as this is what the customer is seeking. They will have looked around the world for markets ripe for some additional competition. Despite what they said about now ‘concentrating on growth opportunities in Europe’ (I don’t think there are many) there was real potential in Australia. Here’s why the Australian market is attractive despite the tyranny of distance issues around supply chains. There is a duopoly (Coles and Woolworths) meaning there is space for other competitors. As the ACCC noted in their objection to the TPG-Vodafone merger, adding a third like-for-like player into a duopoly does not change pricing or innovation they just split the market between them. Competition comes when the new player brings a different offering and doesn’t compete on a like basis. Kaufland would not have competed as a Cole or Woolworths doppelganger.
Kaufland was offering, probably for the first time, grocery shopping as an experience. Australians who happen to do grocery shopping outside of Australia (even in New Zealand) are amazed at how much better that experience is compared to our domestic offering. Because competition here is so weak there is no need to spend money on fit-out and ambience. Close shelving, unattractively displayed product with awful lighting is the Australian way. Let’s get you in there, your wallet opened and out again. It feels more like a 2 or 3 sitting cheap restaurant rather than high-end degustation which is more the Kaufland model. A model that we now won’t experience.
So what were the Board thinking pulling the rug from under our feet? Were they stupid in the first place? Maybe so… we’ll never know. What they did do was act fast. What they didn’t do was suffer from the sunk cost fallacy phenomenon. From a behavioural economics perspective this is defined as when an individual or company continues a behavior or endeavor as a result of previously invested resources. This fallacy, which is related to loss aversion based on past inputs can also be viewed as a bias resulting from ongoing commitment. It’s the old ‘we committed to this endeavor so let’s double down on our efforts to make it work’ thinking process. We have after all spent so much money on it already. It’s a human foible to be sure, but one that investors require highly remunerated board directors to avoid to protect long-term value. They don’t always get that right. In fact it’s probably the exception rather than the rule.
While the sunk cost fallacy creates a strong pull in favour of the status quo, it is often running parallel with other decision biases that when experienced together makes it very difficult to take the brave and decisive decision. The first of these is the confirmation bias. You made the decision to attack the Australian market so when this is questioned you look for information supporting this decision and reject the data that undermines it. This is reinforced by anchoring. When you made your mind up first time around you really committed to it like an anchor. It takes a lot to shift your position. We’re often told to trust our initial judgment and instincts. Now you’re getting data which said we should pull out and hell we haven’t even sold a single item…don’t think so! Not on my watch…we can turn it around…just a little more money in the marketing budget…improved supply chains…better suppliers. Next thing you know you’ve been in for five years and still no profit!
Let’s look at what would have been the competition for Kaufland; Coles and Woolworths. Would they have the board room nous and sophistication to see off the new rival? A good place to look for evidence either way is to determine whether they have had their own sunk costs fallacy pivot points and how they each reacted to those. And as it turns out both have had similar moments. So how did they fare? Well each mirrored the mistake of their rival (I’m saying rival rather than competition advisedly as two players in the market rarely compete in the truest sense). Let’s take Woolworths first up. They launched the Masters ‘big box’ hardware business to take on Bunnings, part of the stable of rival Wesfarmers. It was pretty obvious to me and many others that it was doomed from the get-go but they plowed on anyway with the full energy and focus of a lemming heading for the cliff’s edge. Where Kaufland pulled out of the headlong surge and managed to walk away, Woolworths plunged over with vigor. Do you see a Masters around today? Well perhaps, as some of the abandoned retail warehouses may remain un-let. It’s a dead brand though with egg over the face of the directors and egg in the wallets of the investors. A better case of the sunk cost fallacy you’d be hard pressed to find….
…that is until you look at Wesfarmers who owned Coles outright at the time. Clearly buoyant from seeing off their rival Woolworths, they embarked on the crazy plan to compete with their lookalike in the UK, B&Q, by, and you cannot make this up, buying the UK equivalent of Masters (Homebase). What were they thinking? Well I don’t think they were, at least not uncluttered from bias. Here the Board clearly had, at some juncture, a sunk cost fallacy decision point and pushed on. I think their concurrent biases were the gamblers fallacy which is expecting past events to influence the future. They had been able to take Bunnings from the relative obscurity of Western Australia and crush its rivals in the east and become pretty much a monopoly. Surely they could do it again? They won once they surely will win again kind of thinking. They also probably suffered from over-confidence bias. They were placing a lot of faith in their own knowledge and opinions. They clearly had an unrealistic view of their own ability to make investment decisions on behalf of the shareholders. The rest is history. Wesfarmers pulled out of the UK, tail between its legs after dismal sales figures. Just like Woolworths they plouwed on even when the writing was on the wall.
That’s why what Kaufland did is so remarkable. It’s not easy to bail out when you have so much invested, financially, reputationally, personally and psychologically. Kauf in German means ‘purchase’ so Kaufland means ‘purchase land’. And boy did they in Australia; a mouth watering $20m buying the old Bunnings site in Burleigh on the Gold Coast in 2018 being just one example. Despite this, when they couldn’t make the business stack for whatever reasons (and there’s plenty of speculation about this), they put all bias aside and withdrew. It’s brave, canny and staggering in equal measure. Oh that our Australian companies, in whom we trust our retirement superannuation, had leadership metal like this!