The Woolworths and Wesfarmers-owned Coles quasi-duopoly structure is under threat from global discounters Aldi, Lidl and Costco, which each offer consumers significantly lower prices for everyday products.

New competition is driving significant change within the Australian supermarket sector. Woolworths and Coles are ripe for attack given their world-leading profit margins and dominant market share. Over the past decade the two majors have benefited from a lack of competition in the discount end of the groceries market.

Coles’ and Woolworths’ margins grew from 3 to 8 per cent over 15 years as competition diminished and they leaned on suppliers to keep costs down. The companies and their shareholders have had a longer period of profitability, painting an attractive picture for global discount operators with a track record of success and disruption.

If we look at the United Kingdom experience, supermarket chain giant Tesco suffered significantly from the entrance of low-cost competitors. In five years its share price declined by 50 per cent, a large factor being the increase in competition.

German discount supermarket chain Aldi has 9000 stores in 18 countries and its success in rapidly gaining market share in new markets has attracted global attention. The company managed to reap 10 per cent of UK market share over 25 years, driven by its lower prices and basic discounted offering.

In Australia, Aldi has achieved greater impact and faster. It has taken almost 10 per cent market share in 10 years. So while Woolworths and Coles have the benefit of learning from the UK experience, we expect to see the similar dynamics in Australia. Smaller local players will also be hit.

Aldi’s sights are now firmly set on expanding through South Australia and Western Australia to further add to its east coast presence.

Another German discount supermarket chain, Lidl, has also successfully penetrated offshore markets and is earmarked to open its first Australian store in Melbourne this year. American discount giant Costco operates under a highly successful subscription model, with the majority of its profitability coming from its $65 annual membership fee rather than product sales.

While we expect Aldi, Lidl and Costco will reduce Coles’ and Woolworths’ two-thirds market share over the next decade, consumers will be the ultimate winners. Greater competition from the new entrants will increase choice and lead to lower prices. It will also see an expansion of home-brand products on the shelf.

If the UK example is anything to go by, Coles and Woolworths will struggle with lower margins and reduced market share. However, the two majors in Australia have the advantage of learning from the experience and are pre-emptively adapting to the changing industry dynamics.

With its sales figures recently cut, Woolworths is looking to stop the bleeding. At its recent strategy day, management pointed to neutralising Coles while containing Aldi on pricing.

Meanwhile, Coles supermarkets is nearing the completion of the investment turnaround initiative it began over five years ago. This has resulted in better sales results, particularly as a result of its refurbishment program.

Both players are also looking to expand their online presence and enhance customers’ online shopping experience.

Supermarket revenue represents the majority of Woolworth’s earnings, while it only accounts for 40 per cent of Wesfarmers’.

How Coles and Woolworths adjust to the heightened level of competition that is coming in Australia will be a major determinant of their profitability over the next decade.