Aldi: Hard Discounter Business Models | In Practise

Aldi: Hard Discounter Business Models

Former CEO, Aldi UK

Learning outcomes

  • Aldi's approach to market entry: key criteria Aldi looks for when evaluating the attractiveness of a market to enter
  • Aldi market entry strategy: time horizon to establish a relevant proposition at scale
  • Aldi market entry strategy: process for setting up a supply chain for locally sourced products
  • Discounter disruption in grocery retail: how the (short term) management incentives of incumbent retailers play to Aldi's advantage when entering a new market
  • Aldi's philosophy in dealing with its supplier base
  • Aldi vs mainstream retailers: strategic options mainstream retailers have to combat the threat posed by Aldi and Lidl (price investment, cost reductions)
  • Aldi's approach to managing costs: how Aldi has put cost control at the heart of corporate culture
  • Aldi’s cost structure of operations versus a mainstream retailer
  • Aldi's approach to Talent Selection and Leadership Development
  • Aldi Market entry economics: typical capital investment Aldi has to make when entering a new market to reach break-even
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Executive Bio

Paul Foley

Former CEO, Aldi UK

Paul started his career in 1974 and has over 40 years of experience in retail. The bulk of his career was 23 years at Aldi Süd, a privately held, German-headquartered global retailer, with operations in 10 countries covering Europe, US and Australia. During his tenure, Paul served on Aldi Süd international management board. He was the CEO for the UK and Republic of Ireland from 1999 -2009 as well as identifying and implementing new business opportunities, including entry into new geographies (including Australia). He is currently serving on the board at GIPPO Hypermarkets in Belarus, VOLI in Montenegro, BIM in Turkey and FORTENOVA in Croatia. Read more

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To begin, Paul, could you take us through your career experience in a bit of detail?

I started my career back in the 70s with a firm called Iceland. It’s still running today. It’s a pretty powerful frozen food supermarket retailer. I cut my teeth in operational management with that firm and I’m eternally grateful for all the experience that they gave me. I stayed there 12 years from the boyhood 18 years old to around 30. At this stage, I got a chance to join a new business coming to the UK. It wasn’t a new business overall. The company was Aldi. It was planning on an assault on the UK market and it was looking for management to help it get some traction. I joined them. After some really big consideration because I had a lot of fantastic experience from Iceland. I stayed the next 24 years with them. The last ten, I spent as the CEO of the UK and Irish business. The bulk of my career has been spent with Aldi. Then let’s say the twilight of the career was to do something on my own in an advisory and board role practice. First of all, actually, for Aldi, I was still part of their organization for three more years in an advisory capacity. Since then, I’ve joined a number of boards and set up an advisory team that focuses mostly on the emerging markets and mostly in the discount space. That’s where I am today.

If we can go back in history to your words: Aldi’s assault on the UK, where you got involved at a very early stage. The earliest stage of Aldi’s presence in the UK. Can you take us through what the logic was for market entry and what makes a market particularly attractive to a hard discounter like Aldi?

I’m happy to do that. Some of the points might be a bit surprising, to be honest. When a discounter like Aldi, I have to say my knowledge is that Lidl is similar in its approach is looking for new markets. It has a number of criteria which are important for it to feel comfortable and to feel confident about that market. The first is probably obvious. They’re looking at the discount penetration. If there is none and when Aldi was looking at the UK, there was just a firm called: Quick Save that seemed to be struggling a little bit in its positioning and its success. That was it. There was no other player on the market, and they had around two and a half percent of the market. Discount penetration is a critical first factor. To give you an example. If you were a new discounter, you wouldn’t be choosing Germany as your next market to try and penetrate because there’s already 45 percent of the entire market controlled by discounters there. That’s number one.

Number two is that you’re actually looking at how rich and successful the industry is. To give you some benchmarks and examples. Across the world, on average, a good food retailer can earn five percent EBITDA and three percent net profit. If you’re anywhere above that, the industry would be considered rich. When Aldi entered the UK and was doing its market entry study, most of the good players who were dominant on the market had actually double-digit EBITDA figures, more than ten percent. Double what the global average was. What that actually means is that they had relatively high prices. They could get away with that, the customer was quite happy to pay those prices because they were good operators and because there wasn’t any alternative. The customer could afford it, too.

What that means for a discounter is it will not have to invest so much money to be significantly cheaper than the incumbent on the market. The third element is that you need a consumer who’s been by global standards, let’s talk GDP per capita, rich for a generation. What happens when you have that kind of situation is people have expectations of what they consume. They are not willing to eat things that they don’t like just to get enough calories inside them. They have enough money to be able to consume exactly the quality level and the taste profile that they’re either used to or want. Furthermore, the postman and the hedge fund manager, at the core of the diet basically eat the same things. Same cornflakes, same jam. Same milk, same beer. Same cheese. Same bread. All the core of the diet is pretty consistent irrespective of what you’re earning. It only diverges when you talk about niche products. The postman is not buying champagne every week, but that’s not the core of the diet either to be honest.

This is very important to a discounter and why? Because a discounter wants to come with one product in every particular category. Not a wide choice of product, but one product and it’s got to appeal to the majority of people in order for it to be successful. Finally, as a hope, I would say, a discounter like Aldi when entering a market would prefer that its competition is stock market listed. Stock market listed companies have programs, management incentive schemes, which means that the management is not likely to react to a new threat until the last minute. They’re whole compensation package, what is expected of them as a management team, their contracts, their job descriptions are all based on maximizing shareholder value, maximizing profits.

Taking some threat 15 years into the future and trying to cancel it out now by reducing your prices and reducing your profit, that’s just not on the agenda of a publicly run company before it has to. It buys the discounter a period of time of going under the radar. Nobody takes any notice of it until hopefully from the discounter’s perspective, it’s too late. These are the criteria that somebody like Aldi is looking for.

When Aldi is looking to enter a market, as in the UK, these conditions appear to have been met, what sort of time-frame is Aldi looking at to build the business? Paul, if you could perhaps highlight some milestones, whether it’s scaling operations, supply chain, buying, when does a discounter really start to be a threat to incumbents?

That’s a super question to be honest because that is a very key part of market entry strategy. At what stage will the discounter be able to enjoy some success? I can tell you it’s never at the beginning, never. There are two reasons for that. First of all, food retailing is a scale business. If you haven’t got scale, then you don’t have any success. The second reason is that food retailing is a local business. What I mean by that is, the diet of the Great British public is quite different from the French or German or Australian or UK. It doesn’t matter if you’ve got a big business in another country, if you try to bring the products from that other country and capitalize on that kind of supply chain, actually you’re just bringing foreign product, which will taste different, look different, smell different. It doesn’t matter, but it’s different. All of the people that are listening to this that have never travelled will know it’s very interesting to go and drink coffee in France or eat cheese in Belgium or chocolate in Belgium. It’s not what British people grew up with or vice versa. You need scale in the market you are in. The only way to get that is to build out stores. This takes time. If you want a precise time scale, it’s relatively easy to work out mathematically.

What you want to be as a discounter is, you want to be the biggest purchaser for private label product, because that’s what the business is based on, of the products you are going to sell. You simply look at the stats. You look at the market leader. You work out what kind of private label business that they actually have. That becomes your target in every single product category. Then you need to do the math. How many stores do I need to rival those guys? What that means is, you’re generally talking about ten/fifteen years. Especially for a company that’s leverage shy, which Aldi definitely is. It basically wants to grow out of its own cashflows and profitability, rather than having huge borrowings. It builds a long-term plan to build up enough stores. To build up a local management team that can one day boast that it’s got that buying power. That buying power, it feels very confidently, even arrogantly I would say, will bring it success. Whatever. That is basically the concept. When we entered the UK, it was understood that it would take ten to fifteen years for the business to be really successful. It took that long. It was an accurate estimation. Once we got the buying power that was superior to anybody else’s, there was basically no looking back.

In these early stages, Paul, how do you set up that supply base? Is it a question of calling up incumbent private label producers and tapping up marginal supply? How does that actually work? What sort of environment do you face in building up your supply?

In that, I have hundreds of interesting stories. Actually, you have to see it this way, when an industry like UK food retail industry was in the very late 80s/very early 90s is super rich. Is earning double what the worldwide industry average is. Everybody does well out of that. I don’t just talk about the retailers, but all of the suppliers are doing well out of it. All of the transport companies are doing well out of it. All of the real estate providers are doing well out of it. Everybody gets a bit of the action. The only person that doesn’t do particularly well out of it is the consumer because they have to pay more of their hard-earned cash to get their groceries and stuff that they need to run their lives. If you come as Aldi with a clear track record that you’re there to undercut all of that. To mess it all up. To ruin the party. You’re not welcome. There is no established player, never mind the competition, who wants to help you. Actually, you’re like a plague of locusts I heard it described from people in the early days. Just coming here to suck all of the profit out of our industry.

Frankly, that’s true, that’s absolutely true. First of all, what we had to do was we had to bring product from abroad, which was not a comfortable situation. It was more expensive than it should have been. It wasn’t the right taste profile, but we needed something to sell. Secondly, we had to establish relationships with small upcoming suppliers who were looking for some vehicle to grow themselves. In many cases, we actually invested money with these companies, either by way of long-term contracts or actually buying the machinery ourselves and renting it to them.

Basically, we did everything out of those first 15 years to get ourselves what our goal was. Which is to match the quality level of the best-selling brands on the market. Now, some of that was easy. We could do it within four or five years. Some of it was dreadfully hard. You try making a KitKat even in a normal chocolate factory, which rivals a KitKat. It is really difficult to do. Either the chocolate mushes into the biscuit, or the biscuit is too hard and breaks your teeth. So on. It was really a journey to end up with a thousand products, which truly were rivals for the best-selling brands on the market under the private labels which the company was doing. Enormous fun. I never had a corporate lunch in 25 years because every midday, I was involved in testing product to see whether or not you could tell the difference between the Aldi version of Cornflakes and Kellogg’s. Or the Aldi version of Ketchup up and Heinz. Eventually, we got there. It was truly very difficult to tell the difference. That’s when you’ve got a business concept, which the majority of consumers will not turn their noses up at.

Looking at that business today, what share of the offering will be supplied locally now that Aldi has been in the UK for close to 30 years now?

The true answer to that question is about 50 percent. The true answer to what does the UK consume is the same. Around 50 percent. I know that everybody understands English breakfast tea, but we all know that there’s no tea grown in the UK. Adli UK imports in terms of ingredients or in terms of final product, pretty much what the average is for the market. If you ask me what the answer to that question in year one to three, it was more like 90 percent came from abroad. It wasn’t bad stuff. Actually, in some ways, it was higher quality. If you were a true confectioner and you understand chocolate, you will know that people in Switzerland and Belgium eat a much higher quality chocolate than Cadbury’s. If you don’t grow up on this much higher quality chocolate, it’s the Cadbury taste you want. No matter what you put in front of the customer, if it doesn’t taste like Cadbury’s, there will be a significant of people that will say, “Thanks very much. That’s not what I’m looking for.” Matching the local expectation becomes the goal of the product.

To situate some of the phenomena we’re talking about in historical context. As you mentioned, as part of your plan originally, you expected ten to fifteen years to hit scale, that must have happened just shortly before the financial crisis or in the few years running up to that. Paul, could you take us through how the incumbents dismissed the threat for quite a while?

In some ways, it can sound like the incumbents were sleeping at the wheel. I’ve even heard that phrase. I actually don’t think that’s fair or realistic. If I was running Sainsbury or Tesco at the same time, I’m not sure I would have done anything different, to be honest. After ten years, Aldi had a couple of percent market share. A couple of hundred stores or a bit less than a couple of hundred stores. It was growing. It was an irritation. It wasn’t really a threat. These guys are faced with historical decisions on property, on infrastructure. They’re trying to make the best out of that for the shareholders in terms of profits. Actually, they did a very good job I think from year to year.

The Aldi model is this slow, creeping juggernaut which just doesn’t stop. As it gets bigger, it increases by ten percent every year. That’s more stores every year because you’re coming off a bigger base. First ten years, nobody really took any notice of us. Other than from time to time reminding their own supply chain, if you help these guys, first of all, you’re stupid because they’re going to not only make our life difficult but they’re going to make your life difficult, too. In terms of pricing and economics. Secondly, we’re not going to be pleased with you helping something that is a competitive threat. I met a number of top managers of competition and really senior management. They were not sleeping at the wheel. They knew what was coming, but they didn’t really have the necessity or motivation to change anything there or then.

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Aldi: Hard Discounter Business Models

May 11, 2020

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