Hard Discounter Business Models: Aldi's Disruption of UK Food Retail | In Practise

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Hard Discounter Business Models: Aldi's Disruption of UK Food Retail

Former CEO, Aldi UK

Why is this interview interesting?

  • Aldi's core business philosophy: keep cost low, restrict range to high-volume products, and keeping the customer shopping experience to the most basic neeeds
  • How Aldi disrupted Tesco's business in the UK

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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Interview Transcript

What are the main lessons you learnt from your years at Aldi on how to build a discount grocery retail business?

Well, It doesn't matter if it's a discount business, or any kind of business. If the core philosophy is unchanged for many years and the majority of the people that are in the business believe in that core philosophy then normally that's a huge strength. When trying to evaluate a company these days, most analysts make the mistake of doing most of their analysis on paper. They look at sales, they look at sales growth, they look at margin, they look at profit, they look at return on capital. You know, all the things that you can calculate and that you can see on paper. And these are very important but they’re outcomes of other much more important fundamentals. If the management team changes every 3 years then I start to harbour a deep suspicion in the core philosophy of that business.

I don't mean that they never have a new person because of course as you get bigger you always need new influences. But if the life expectancy of the management team is too low then my experience is normally that that business does not have a core philosophy and it gets remade every 2 or 3 years. That can be good for certain periods of time but that can also be very bad. More often than not, it's negative rather than positive. If you look at the staff churn, that's not the top management team now, but the masses that work for that organisation, if those people stay much longer than the industry average then that's a very good signal. Conversely, if they don't that's a very bad signal. I talked about the need to get the entire team behind a certain point and believing in it, that's 1000 times more difficult when they're changing every 6 months, every year. And those kind of churn rates are not so unusual in the food retail business. So, find companies with 3, 4, 5 times slower churn, and normally you see strength in those businesses. These are the kind of things that are not so obvious on paper.

What is Aldi’s core philosophy?

Well, it stands on three principles. The first one is that Aldi is totally focused on being the food retailer, in any one market that it operates in, with the lowest costs. It is absolutely religious about that. It works day in, day out to make sure that that is a claim that is always true. So it’s constantly trying to reduce its costs and it focuses very much on those costs being a percentage of its turnover. So it might not actually decrease the pound notes or the actual physical dollars but it is always looking to decrease the cost as a percentage of its top-line sales. So that's principle number one.

Principle number two is that it stocks a restricted range of products. The restrictions are as follows: they have to be relatively high volume products, so that there is huge scale gained out of selling that item; secondly, that the quality pitch of those items should be where the people who are consuming them currently choose to purchase. It's pretty simple to just buy data that tells you: many more people like an orange juice that is 100% pure, that comes from sustainable sources and has a certain brix level (that's the sweetness level). So you identify “that's what people want,” and they’re proving it by best selling brands being in that space, and the Aldi product has to rival that. There are a whole set of business processes to ensure that it doesn't just say it, it does it. So that's number two.

The third one is to very clearly identify what is really necessary for the shopping experience: it could be car parking, it could be fast check-outs, it could be a certain lighting level, and you must do it. Also, identifying what is not so necessary, like in-store music or service counters, and you do away with it, which actually helps topic number one, keeping your costs ever better.

These things are dynamic by the way. First of all, your competitors are also trying to reduce costs, so you've got to keep going with that, and you've got to have constant workflows that are coming up with ideas to reduce costs. Secondly, the consumer changes their mind with more information or understanding about what products they want to buy. You've got to be constantly on top of that. If a brand invents something new - just think of, in your lifetime, washing powders, they've gone from being just a powder to being a tablet to being a liquid then back to being a powder again (the third one is a concentrated powder, by the way) - if you're not keeping up with that, then you're just left behind. The process of what customers value in terms of their time also changes. So you've got to be constantly monitoring and up-to-date with those trends. That's the Aldi job: those three things. Focus on those three things and do them well then, as a discounter, you will be successful.

Paul, to add to that then or maybe a dimension here that I think is really interesting, is to understand the business’s approach to strategy and capital allocation. What I’m really drawing out is a point that you made a little bit earlier on time horizons and the virtues of being a private business in trying to understand the way in which Aldi seems to have very methodically and very purposefully scaled up the business and grown to an incredible scale. Again, from an outsider’s perspective, against what seems like quite a challenging odds. What was the strategy of the business and the way it deployed capital in bringing these values and philosophies to life?

Well, I mentioned to you that I can't really take credit for the vision part of it. The vision was already set by forefathers of the business. What that does is it gives a certain amount of money, it was quite a lot by the way, it was close on half a billion US dollars, which needed to be invested to have stores and warehouses and buying power. It gives a certain amount time because there's the fixed cost of the assets but there is the variable cost of the people. And when you're not making money, those people are a kind of burden on the business. So there is a certain amount of time and some clear targets.

I knew before I started, “I've got this amount time, I’ve got this amount of money,” and I was expected to build a business of certain size, that would then start to make returns. It pretty much proved to be almost spot on. Of course, I would like to boast that it was well executed, that it was well done, and by the way, it's gone on to be more successful since I'm not there. The years 2013 to 2019 are tremendously successful for Aldi UK, more successful than the previous 5 or 6 years that I was in charge. So, well done to the next generation of management. That's all part of a story of a business that has got a certain philosophy and where that philosophy doesn't change, and there's a succession plan, and people stay for 25 years and then move on or retire, and the next generation is expected to do similar, if not better.

Right, and so as you were saying, this play book is well established. This business has been around for a long time. It's had repeated successes across international markets. It's scaling up operations and taking up meaningful chunks of the market from otherwise well established and successful incumbents. Could we talk about the Tesco case study in this context and what you think was really hard for them to appreciate about what was happening to their industry and about Aldi’s vision for the UK market.

Well, first of all, you've got to see, that when disruption happens, which it has happened before in other markets but not in your market, and you're a public company, and the management team is incentivized based on keeping performance going like it went in the past, it's rather difficult for that management team to suggest that they should slow down financial performance, invest in another direction, and get themselves fitter and leaner for a new level competition and there's the Tesco story.

In the year 2000, Aldi was already 10 years in, it hadn't really made much impact on the market, still only had one and a bit percent market share. Food retailers the likes of Tesco were growing dramatically at the expense of their much-bigger-than-Aldi peers that weren't able to keep up with the Tesco story. And so you kind of start to believe in your own rhetoric: “Well, we saw off Sainsbury and overtook them and then became double their size. We've gobbled up all these regional players and successfully turned them into more profitable businesses as part of Tesco. So what is this Aldi thing? We've beaten Kwik Save to the point where that discounter just disappeared. I don't really see that Aldi is any kind of greater threat than we faced in the past. A smarter manager would have got on a plane and come to countries where Aldi has 20% market share or Aldi and Lidl between them had 20% market share and seen that actually this might be something to contend with in the future. This doesn't look like Kwik Save.

They didn't do that and that was mistake number one. Mistake number two was that the boards of these companies incentivised their managers to make quick returns and their competitors, Aldi and Lidl, were seeing things in a much more long-term way. They didn't recognise that either until it was too late.

Thirdly - which by the way I think explains Tesco’s Jack’s experiment of today - they didn't really understand the business model of Aldi. “How can it be that when we have 40 000 products, that this business with 1000 can be as successful as us? That just can't be the case. They have to be at least 40 times less successful because we've got 40 times the product options for the customer.” Instead of really looking into what makes that business successful, they just kind of ignored it, until it got too powerful to ignore. And then it was too late to do anything about it.

What I think Tesco have done particularly in the last 3 or 4 years is a very successful way of fighting bank: lowering costs, learning what the Aldi model is all about, finally setting up their own discount operation, so they've got a constant learning academy, as to what might come next from Aldi and Lidl.

So that's a part of the company's history at Tesco. It's a pretty painful part because management teams got thrown out the window, the profit for the business swung into a loss, parts of the business were written off. Basically all mistakes of the past. And that could have been avoided had they had the same approach they've had in the past 4 years. Fortunately for people like me, they didn’t do it.

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