Supermarkets on brink of new price war

A supermarket price war will break out this year, slashing profits at the big grocers, if Sainsbury fails in its attempt to regain market share by other means. According to Verdict, the retail analyst, the likelihood of a damaging fight for dominance of the saturated food retail sector is greater now than at any time since the early 1980s. Kwik Save and Iceland are expected to be the biggest losers in the imminent battle.

Following last Friday's profit warning from Sainsbury, which wiped more than pounds 1bn from the value of its shares, the former sector leader is expected to come under increasing pressure from the City to revive its fading fortunes. David Sainsbury, chairman, shocked the City last week by telling analysts their forecasts were pounds 50m too high.

According to Verdict: "Competition has never been more intense in grocery retailing. A hierarchy of retailers has emerged with four players at the top. It is clear looking forward that all four cannot perform well at the same time. Something has to give."

A return to the use of price as the grocers' main marketing tool would hit all the supermarkets' return on sales but Verdict expects the hardest hit to be companies such as Kwik Save and Iceland that do not enjoy the benefits of Sainsbury's and Tesco's economies of scale.

Only the largest chains are currently in a position to launch and win a price war. Although Verdict believes Sainsbury is the most likely initiator of a price war, Tesco is expected to launch a pre-emptive strike if it thinks Sainsbury is about to open fire.

The need for Sainsbury to act has been heightened by the establishment by Tesco of a 2.6 percentage points market share lead. Tesco is widely seen as having been more innovative in product development, marketing and store design. It has narrowed the gap with Sainsbury in both sales density and operating margin.

With 20 per cent more sales area than its main rival, Tesco is expected to consolidate its position in future and put big resources behind building its brand reputation and widening its lead over Sainsbury.

Verdict's report says: "Tesco's supremacy goes way beyond marketing expertise. The huge strides it made in improving product quality, ranging and customer service means that Tesco is delivering the promises made by its marketing."

The battle between Tesco and Sainsbury will be one of the most significant events on the high street this year, with the grocery sector estimated to represent 38p of every pound spent in Britain's shops.

The sector has taken on a significance well beyond the size of the food market - total grocers' sales of pounds 64bn are 25 per cent more than the total amount spent on food.

The renaissance of value for money as the driving force of the supermarkets' sales efforts marks a shift away from the use of loyalty cards that has dominated the past year.

The cards have proved expensive to run and the jury remains out on whether they can retain shoppers' loyalty in the absence of product innovation and good service.

Asda has already said it sees the cards, which were first launched by Tesco, as a distraction from its core retailing skills. The cost of Sainsbury's Reward scheme was put at pounds 10m last week and although the cards provide the company with valuable information about its customers, they are not generating sufficient new revenue to cover their cost.

As well as facing a threat from the majors slashing prices, the plight of the traditional high street grocers has been exacerbated by a second squeeze from hard discounters, led by Aldi, which has made a determined play for the lower end of the market. According to Verdict, it is seen as providing a better service to the poorest end of the market than Kwik Save and could become even more of a force if a merger of Aldi, Netto and Lidl were effected.

Another issue affecting many food retailers is management succession, with Asda, Safeway, Sainsbury and Tesco all seeing changes at the top.