November, 2013

Fruits of Thought

Time Is Ripe For Deep Discounters

Tesco’s ill-starred venture into American retailing is now history. Of course, while the British were getting all the press, it was the Germans who were showing all the growth. Aldi now has over 1,200 stores in America, and Trader Joe’s has nearly 400 stores.

Between the two concepts, it is Trader Joe’s that gets all the attention. Its epicurean nature catches the fancy of the foodie class as well as of the white collar scribes who write for food magazines, major newspapers and food-oriented websites.

Yet Trader Joe’s is so unique it is difficult for others to enter its space or duplicate its concept. So it is Aldi and the broader deep discount category that poses a challenge to the food retailing kings of today. And it is in cracking the code of how to use these value-retail concepts that the production community will find new opportunities. This category is set to become the new center of attention in the food trade.

It is notable that when Supervalu sold off almost all retail operations, it hung on to its crown jewel — the Save-A-Lot deep discount division. Now, all across Europe, the buzz is that The Schwarz Group, Europe’s largest retailer, has decided to open its Lidl deep discount operation in the U.S.

U.S. retailers are very vulnerable to this deep discount competition. These new operations are built around small stores with limited assortments, and one big edge these concepts have is that they are easy to site. Every time Wal-Mart talked about opening stores in New York City, it became World War III with politicians and unions. Meanwhile Aldi quietly slipped in and opened stores at existing sites in Queens, the Bronx and Manhattan without a fuss.

Aldi is just as non-union as Wal-Mart, so that is not the issue. The issue is that large supercenters typically require new construction which depends on variances, zoning modifications, requires hearings, etc. Aldi can slip a store into an existing strip mall; if building a stand-alone store, it is typically building “as of right,” and requires no variances, etc.

The other big edge is that the limited assortment model actually is cheaper to operate. We have known this for some time as warehouse clubs play basically the same card: take the 20 percent of supermarket items that account for 80 percent of sales and just sell those.

Warehouse clubs, though, added two big caveats to the deal: first pay a fee and then buy only in large quantities. Yet those who are most focused on price are those least inclined to pay fees. The requirement for large volume purchases raises the cash outlay necessary to access the bargains and, if the buyer doesn’t have a large family, raises the requirement for volume purchases — especially on perishable foods. This may result in so much waste that the bargain becomes lost.

This month’s cover story, “‘Discount’ Opportunities: A New Day Dawns As Deep Discounters Ramp Up In America” starting on page 24, shows how the deep discount phenomenon is transforming British retailing, and thus lays out a picture for what may be ahead in North America. Those who have a vision of British retailing in which an oligarchical “big four” dominates everything are living in the past. A much more competitive dynamic is at play today and, in no small part, this is because of the German deep discounters.

The key factor that turned this sector from an asterisk to a key mover of category trends is that the deep discounters decided to transform their business models from simply selling cheap to, instead, selling quality goods at a low price. It sounds an awful lot like Costco without the fees and the requirement for bulk purchases.

Some have been inclined to dismiss the rise of the deep discounters as a consequence of tough economic times and, as prosperity returns, they expect the sector to grow more slowly. There are real reasons, though, to think this vision is off. One is that consumers have changed; this recession has been longer and deeper than any before. Just as the Great Depression produced a mindset of thrift and economic conservatism in a whole generation, this long recession may have changed the way people feel about waste and extravagance for decades to come. 

Another point is that the move to quality has made the inexpensive deep discounters very suitable for the lifestyles of more affluent people. Just as it is true that the parking lot at Costco is filled with luxury vehicles because rich people like saving money on their purchases just as poor people do, so many affluent people will find products to their liking at deep discount stores.

In fact, this move to quality is manifested in an expanded emphasis on fresh produce, and here is where the future gets fuzzy. On the vendor side, careful cost analysis is imperative. What is saved by not having to deal with low volume items? What is the real benefit of having a high volume customer who wants quality, but will, perhaps, accept a size other supermarkets won’t? 

On the retail side, this is a sticky wicket. Deep discounters undercut pricing at Wal-Mart, consequently shifting Wal-Mart into a difficult middle-market position. But all retailers are vulnerable as consumers incorporate deep discounters into their shopping mix. With high fixed expenses, a shift of 5 percentage points to deep discounters will seal the fate of many stores.                                                  pb