How has the Spanish supermarket industry structure evolved over the last decade?

Yes. We need to go back to the years 1985, 1990 when the hypermarkets appeared in Spain. I mean, the Spanish market was always driven by hypermarkets and then the French players like Carrefour and all of them began trying to expand all across Spain.

There were some Spanish players already doing some supermarkets, not hypermarkets, and then some of them got afraid and sold the business. Mercadona took the approach the approach and said, "Yes, I need to go to the US market and then try to understand how I could design myself from somebody like these hypermarkets," and so they went away and we work the foundation of Mercadona that we will discuss later on.

Mercadona, today the leader in Spain with 25% of the market, they were local guys in Valencia with a small supermarket and even the family of the current owner, second richest man in Spain was a butcher's family. As time elapsed, then the Spanish government, what they did is they decentralized the obtention of the commercial license. They were doing this especially out of a strong pressure from the Catalonian government, but they have always had a very strong opinion into retailing in Spain because the Catalonian guys, I mean, if we look at trade or retail, Catatonia has always been very, very strong.

They wanted to defend the small and local shops, so they pressured the Spanish government to decentralize the licenses. And then basically, the regions decided no more hypermarkets. They said, "Now it needs to be a supermarket," mid-size supermarket.

We have 17 autonomous communities in Spain or regions with 17 governments, so not all the ruling is such in the same way. For example, Madrid is extremely open to business, and we can open 24 hours, and then there's these licensees and so on, but in Catatonia it's impossible, you can't open on Sundays and very limited.

What has happened is that this has created a very, very different shape of development of the retail market across Spain because some regions basically were extremely protected. Catatonia would be like Italy, where hypermarkets are not present because the Italian ruling is very tough, but then Madrid would be like France, full of hypermarkets because nobody was stopping them from opening.

Mercadona took the advantage, this double advantage. The first one, of course, of assessing what was going to happen and then really setting up a clever business but at the same time suddenly the whole laws says that no more hypermarkets, so then only mid-size supermarket which it was exactly what Mercadona was doing. It got a little bit of win in favor.

Then we got a second phase that is the crisis, in the year 2007 to 2009, everything was glorious in Spain. If you look at the amount of cars we were buying per year is twice the amount of cars we're buying today. We went from two million cars per year we went then down to half a million cars and today we are a million, a million and 200,000 cars. We were believing we were richer than the Germans.

But the crisis hit us very heavy mainly because the Spanish economy was very much based in construction, and these markets just collapsed, it disappeared. When you have something that represents somewhere around 20% of the economy and you're pushing everything behind, banks with problems, with mortgages. Then on the real estates, what happened is that people moved from, let's say, the high-end regional leaders, very nice construction firms into this campus, again, this helped Mercadona.

I remember some friends of my wife who never went to a discount and then they said to me, "Javier, we met some Mercadona," because they actually started to-- and this, it was another win in favor of Mercadona that even the crisis, not only hypermarkets were stopped and then the format was good, at the same time the consumption was moving to these counters, so this was a big time for Mercadona.

How did the market change in terms of store count or square footage?

The reality is that if Spain has always been very steady even here in the crisis, we have every year somewhere between 2% to 5% new ascend space. This sounds a little bit strange because the market during the four or five years of the crisis was decreasing, but just who was up in there and it was Mercadona leading, so the discounters and Carrefour was also quite okay.

Let's say the leaders of the sector have never complained, have never ever really, perhaps they review the speed of openings. I remember Mercadona, at peak times, were opening 100 stores per year and then they went down to 60, but they were still open. This is part of what we have discussed on the past in Spain. The concentration of the top players it's happening but it's happening because the good performers continue to open. It might seem reckless because in terms of the space we don't need any more space but the thing is that they're killing the non-performers like DIA and Eroski. In a way, it's a strategy, I'm sorry.

Mercadona, which has roughly 25% of the market today. What was the market share split between major players in 2008?

Before the crisis Mercadona was somewhere around 20%. You had for example Eroski with much more relevance. Eroski prior to the crisis were €9 billion company. Today they are €5 billion company. They've lost 4 billion, they've lost 60%, sorry 40% of their sales. Now, this has gone to other parties. For example, these were parts of the players that lost. There are others like for example, regional leaders who had to close down and they were taken to liquidation. All in all the shift you have let's say two kinds of shifts.

One which is winners or losers, and I gave you names of the winners like Mercadona, Lidl and Carrefour. Losers would be people like Eroski, DIA or some of the originals that were not too good. In terms of format clearly, we've moved from big surfaces outside town into convenience downtown. The curious thing is Mercadona has also closed many of their out of town stores and moved also downtown. These shifts from outside to inside.

What exactly is driving consolidation the market? We touched on Eroski and DIA getting squeezed out but what is driving this?

Well, I have this rule, which is the rule 80/20. The rule which is very simple to understand. 80% of the pros that retailers are holding today are commodities. Non-attractive based on price and that at the end, you need facilities to be touched. Those ones will eventually be on the hands of digital players or the digital market. I'm not saying that today that's not been standing, there's still a square space for - but then you have the other 20%, which is differentiators. Things that really motivate you to go there. At the end, good players are having a significant junk of this 20%.

Perhaps not 20% but 30 or 40% within their stores and they continue to innovate and generate new things. On the other side, then you have people who this 80% becomes 90% and because they're simply not innovating, they're not really novelties. They're focused on to commodities and at the end, then the decision for going one on stores is based on your price and commodity. This is not a long lasting let's say advantage.

So it's mainly on product mix and a lack of differentiation between categories drives the bifurcation?

As you know, you and me have discussed that within food retail if we can somehow, let's say, split the categories that makes the difference. You have A brands, Unilever, Nestle, etc. Then you have private labels or a company's own brand, and then you have the fresh articles, fruits, vegs. With the A brands, Nestle, Unilever, everybody has those. Everybody has Coca-Cola and the thing is also that Coca-Cola, Unilever and so on they have these prices to the massive reserves are sold to everybody. When selling Coca-Cola today in Spain, every single store, we set it at the same price because Coca-Cola are licensed to do that.

Although the law doesn't allow that to happen, but the reality is that if you changed your price lower than anybody else on A Brands then the guys call you and say sorry but the track got punctures and I wasn't able to deliver to your central warehouse. A-brands is I believe that differentiating yourself on A Brands is reckless. It has no sense. You need to find either a model like the discounters Lidl and Mercadona where their ownbrand share is high like 60% or 90%. Where people really find that differentiation in these brands. I was giving you, for example, Mercadona issued a cream at 9.95 EUR four years ago. That it was created a massive amount of people going there. Lidl is now issuing some wine and chocolate which everybody is willing to - because it's really on social media and everybody will need to move it.

It's their own brand which is generating the sufficient excitement to go there. You also have people on the other side like the Whole Foods that you have in the UK. People who make the stores very attractive on the fresh. Excellent fish departments. You look at the butchery and meat from everywhere in the world and wines which are excellent. This makes a real connected to this store. Now somebody who is not either in one side or the other one which is the case of Eroski, then yes I will already be Amazon and just send this home in the case of the UK beer.

So why has DIA and Eroski failed to understand the importance of optimizing mix in this way? Are there other drivers at play here?

Well, let's say in both of the cases to me is not, it has also a component of management and management attention. Eroski's attractiveness is not high. They have a share of one third A Brands one sells fresh and one sell on A Brand or private labels which means at the end everything of everything. The problem of Eroski was that they acquired a company in the year 2009 that it was worth €1.5 billion today. Today they will not be able to sell it for more than €400 million. This has created such attention on their debts that the guys are not driving the company anymore. It's now the banks who are driving it. In the case of DIA the guys who didn't really believe in their core asset, which was DIA markets which are proximity scores right next on downtowns and capitals in the Spain.

They invested in cosmetics retail and they invested in fresh retail so not really dedicating time. Today's DIA's own brand which represents 65% of the sales is trading at 9% previous year, simply because it's not attractive anymore. It is because people don't find that really a difference on DIA brands is considered cheap. Having a private label or a brand that represents 65% of your business and that people consider that cheap is very bad news for your business.

Yes. Then you will have, because Fresh at DIA represents between 5% to 7%. The rest would be A Brands. It's 55, 60 so then we will have 30, 35 on A Brands.

No, Mercadona is 60 and then Mercadona will have a higher share on sales it will go somehow to 15, and then a limited share on A Brands. Mercadona is not treating A Brands so well and that's why A Brand's supply has quite upset DIA, because Mercadona gives much more relevance to their own brand rather than fresh. Even if you see it when you go to the stores and you see the placement of the A Brand. Normally in a normal supermarket, you will see A Brands really at the level of your eyes. In Mercadona all the A Brands are at foot level. Really you come to this layer and say guys, what are you doing?

Could you provide a bit of context into the founding story of Mercadona?

Like I told you they were butchers and they were already a wealthy family before Juan Roig, the CEO today, was born. It was a butcher's family that was doing quite okay in Valencia, and then the father decided to set up a supermarket to run along the butcheries. They were doing okay, with 10, 12 stores. Then, one day, Juan Roig, the current leader and, like I said, the second richest person in Spain now after Amancio Ortega, who is the owner of Inditex, Zara, said to his dad, "Dad, I will run the supers." He took all and today, this company sells 20 billion, has 1,500 supermarkets.

The guy on the balance sheet he has no debt, he has €3 billion on cash, so how he can achieved that? I mean, everything on the company that you see today, every aspect, every department of the company has something to be distinguished. If I may start on a list, I would start by products. Like I told you, I mean, 60% of the sales are made by the private labels, they have four or five private labels, Hacendado, Deliplus, Bosque Verde. They have separated on detergents and cosmetics. All in all, the thing is that some of these brands are considered by as A brand's itself in certain categories.

How they have achieved that is because they made that relation with their suppliers which is a very peculiar relation because normally with private label suppliers your relation is based on, "Give me the best price." But Mercadona said, "No, no, no. I want an open-book relation where you are my partner, I'm your partner and we marry with a contract, whereby you can only work for me and if I want to release you, I need to call this releasing for three years in advance'

Contracts are forever, but if Mercadona wants to delist, then she needs to tell you with three years in advance.

Yes. Well, Lidl is different because Lidl has done something similar to Mercadona, DIA is completely used. DIA has gone more into the reverse auction relations. Every year, I see these supplies and I do a kind of eBay auction, but, let's say, not raising prices, but reducing prices. Then, with that, you're getting access certainly to the best prices in the market because you're pressuring supplies year-by-year, but the thing is that what customers today are looking at is not the cheapest on the market, but a good relation between price and quality. DIA has lost that ratio completely.

Going back to Mercadona, like I told you, then they have a 110 of these preferred supplies, they're called interprovedores, and these 110 people, imagine they hold 5% of a company that sells 20 billion. What has happened, just to give you an example. because I had an ice cream company that I bought, a delicatessen company and I was completely against Mercadona's own producer. This guy has become a €400 million sales, where the average ice cream producer in Spain is 100 million and even less, but the thing is I was having 25% EBITDA but this guy was having 3%, 4% EBITDA.

Why? Because Merecadona was saying, "I will provide you with huge amount of volume, but with low margins and we will share--" Of course, I mean, the guy who was selected to be Mercadona's own supplier, imagine, his company quadrupled the sales and he was having the security to have Mercadona. I'm not saying is perfect because you have also some people who left Mercadona and then they said, "Yes, Mercadona killed me because I was having the marriage." But the majority of these guys are immensely rich today and very happy and running very healthy businesses.

How does pricing work with private label suppliers? Does Mercadona say that, "I'm going to give you a flat 3% margin consistently to process x category?"

They discuss this individually to every supplier. It's an ongoing relation. Is every year? No, it's every day. Imagine, I mean, the buyers cosmetics in Mercadona has three supplies, while a normal buyer in cosmetics usually has 40 supplies. I'm saying three which are the key-- one is running that person, the other one is running that person. At the end, the relation among both of them is so intense.If you ask the vast majority of the preferred suppliers in Mercadona are immensely happy. I repeat, some of them not because when Mercadona leaves them, they say there is no life after that because then you're dead. But once you hit, I mean, the people in Spain is extremely happy.

Yes, 110. Then the next thing would be people. In Spain, we have two kinds of-- let's say to simplify it, oversimplify, we have two kinds of contracts for employees which is fixed and variable. Fixed means that in order to fire you I need to pay a compensation variable, I can fire you almost every day without any compensation. Again, I'm oversimplifying.

Mercadona, I mean, on a normal retailer, you will have 50% fixed, 50% variable, just because on Christmas you need to go up and down, and just because perhaps sometimes you have difficult sales, you need somehow a flexibility where the cost of adapting your label would not be too high. Well, Mercadona decided that is having everybody on fix. For some people like cashiers and people on warehouses, you go and ask for a mortgage and you said you are working in Mercadona, you have a fixed contract, then your mortgage goes to be approved, whilst you're in a situation of variable contract, then becomes--

Also, Mercadona, for example, it has the possibility in certain communities, like I told you, to open on Sundays. Not Cataluña, but Madrid opens on Sundays. Well, Mercadona consciously decided, "I don't want to open on Sunday. Although my competitors can, I don't want because I want my people to be with their family at least once a week."

So is the industry average for employment is 50/50 but fixed on variable?

Yes, more or less. Depends also on the age of your company because at the end, you build such a nice relation with certain employees, that the law obliges you in a certain moment that you cannot keep an employee forever on variable. Then, the older you get, if employees are good, then the more fixed contracts that you have.

What are the major drivers of the difference in sales per sqm for the major players?

Yes, square meter, are a good way of understanding attractiveness because sales per square meter also gives you profitability, not highly correlated because sometimes you sell more, but it's quite correlated. Therefore, the best in class in Spain in food retail it's Mercadona, is €9,600 per year, and then worst in class is DIA, with €2,700 per square meters.

Lidl is €7,000 per square meters, number three in the class. Number two is Ahorramas which is a regional leader, their strength is the fresh side. Average of the Spanish market is €5,000, but that is very much because of the strength of Mercadona, having the vast majority of the square meter reach in Spain and having €9,000. Then, you would have people like Carrefour who is also at €5,000. Then, you will have people like Eroski, at 3,700.

It's a wrong format. Like we were saying, Mercadona said, "I want to have the goodness of proximity and the goodies of a hypermarket. They have always been very tough on saying, "I want stores that are always above 1,500 square meters and my idea would be in a strong market 2,000 square meters." With that kind of service, if you don't run normal food, if you're only running fruits, it would be the size of a hypermarket because the average hypermarket would have 4,000-5,000 square meters so at the end, if you're running a 2,000 square meters store in foot, then you're having like a hypermarket. The thing is Mercadona has been opening stores per year, new stores per year.

They would be a 100 opening but 70 closings. Always trying to get closer and closer to downtown and on top of this I call Mercadona, some people say, "It's a hard discount a soft discount." I call it a sexy discount. Why I call it a sexy discount is because the guys although they're not investing as much as Harrods but the stores look very attractive because they have been able think constantly on how could I make the nice lighting, good music, wild eyes and good presentation of the merchandise, but yet not having to invest as much as Harlots.

Just in terms of formats there's Mercadona's 1,500 to 2,000 square meters

Lidl would be slightly above that so moving up to the 2,000 sqm and onwards but the thing is that they are mainly out of town, because as you know in the UK. They have only realized that they need to move now downtown and then now suddenly they're squeezing the stores to the level of what Mercadona is doing.

So format and location are two key drivers of the difference. What are the other key determinants?

No, it's a combination. First of all, crucial is your offer. Whatever you offer is crucial and that's why all Mercadona's own brand is the key success but of course, if you then have nice employees who treat this quite well and you have a communal store with parking and everything and then we can facilitate the whole thing.

Their suppliers are strong and it's like 90% of revenue.

Lidl has concentrated on having four to five brands and has generated a lot of brand awareness and even has an immense amount of brands.

I'm not saying that their cracking us behind is similar to that Mercadona but brand awareness also comes with simplicity. If you ask Unilever honestly how many brands they've been selling on the past weeks they bought and eventually sold to have simplicity because otherwise, people would not remember.

Do you think Lidl can get to the 10,000 Euro per square meter?

I don't think so, let me just explain. I mean, moving from 7,000 to 10,000 that's a 3,000 step which is almost a 50% growth and this 50% you need to do it like-for-like, so it's not but you can open your store, no, no, no. Sales per square meter measure like-for-like growth.

Like I said, it's personal store and product pricing, we said it. People were questioning but then there's is no future for DIA because with 2,700 I said maybe people are not going to shop at only one store for all of the future. The only thing is that you need DIA to move from 2,700 to perhaps 3,000, that would be more than enough.

What is the difference in EBITDA margins between Aldi or Lidl VS Mercadona?

Well, basically is that food retail in general is as low as data margins, so being on the production side, it's always much better or being in non-food retail is always much better, so food retail, it's the lowest. Best in glass in our sector in Spain is the regional Ahorramasthat I told you or a must which with 11%, and then you would have a pack that there's some level of four to five, four to six and then DIA was temporary at seven but this is one of the promise that the company has had, that with a low positioning company having a 7%.

But for example, then you have Mercadona who is going to be a three and half because see the guy owns his company and he is the one who is deciding how much EBITDAwants to get because at the end it's the amount of money he wants to get for his boat, new holidays, new plane.

He decided for the last couple of years if he wants to do, to have and reimburse in the company. Now, imagine how much tension that is creating in the whole of the market because I can not, Carrefourcan not go the shareholders and say, "Guys, let's forget about dividends for the next two years," If you do that then you will have to have a slight problem with you share pricing.

Let's assume an average EBITDAmargin of 3% to 4%. How should we look at the working capital profile of a supermarket like Mercadona?

The only thing is that the guys have decided to pay on 30 days, 75 I think they do have. DIA was paying 90 days, for example, and the law says 60 days. Why DIA is paying 90 because they have a special trade facility issues with banks for a surprise they're paid on 60 days but then DIA doesn't have to pay it in 90 days, yes we need to Euro, we need you to turn your inventory yes?

If you have 3,500 SKU'S like Mercadona versus 12,000 that might be running in an average supermarket, your ability to turn the-- I mean Mercadona should be somewhere on the level on stock on hand, yes 18 days, 19 days, I haven't looked at the latest figures but somewhere on there. Then you would go to a hypermarket which you would have 30 days on hand, so 30, 35 depending if you have non-food.

Similar to Mercadona, yes. Because they have 90% own brand, also they have I would say even perhaps lower but Mercadona is selling silly more for the square meter than is accelerating the whole stock turn because Lidl has less brand, has something like 2,500 so a smaller assortment than Mercadona, but of course, if you have a higher assortment that you're selling faster this could be as fast as the guy who is having a small assortment.

Then players like Carrefour are typically 30, 35 days?

Yes, but it's still manageable. Some people were criticizing "DIA is you just paying too late as with DIA branch" etc., that's not the fundamental issue here. The issue is stock turn. You need to sell more and make sure that the merchandise-- I remember when I started in retail that the issue was how to get merchandise to the shelves now the issue is how to get it out of the shelves.

So 30-35 days payables and then the receivables is-

Customers are paying on cash. You only need to move the stores and the suppliers. Only if you were to have a cash and carry business where you at the end, you're receiving payments from your customers later on, but in retail it's cash on hand. You only need to work with inventories and suppliers. I'm oversimplifying. I'm not saying. You're selling things in 19 days and paying people on 25 days, so you have 10 days of cash.

Let's talk about depreciation which at the end you could more or less is the same as maintaining capex, it will be 0.7%, 0.6%, some companies a little bit higher. DIA on their heavy turns they were pulling capex at 3%, 4% that's because it was acquiring companies.

Again, if you've been to look at Mercadona's P&L, it would differ very between years but pure maintenance capex is 0.6-0.8% of sales.

If you're opening stores then capex reaches up to 2% to 3% of sales?

Yes, it depends on what the speed that you're opening the stores. If you're a starter, then you've got an issue but if you're opening let's says 5% of your new stores every years, then this becomes a little bit less important. In food retail, really I assume that the name of the game has changed from organic growth to pushing your life for live growth. I'm not saying that people organically shouldn't grow, but it should not be any more your essence of your growth, you should really concentrate on your life to live growth.

What would you say best in class free cash for yield would be? We took that 4% or 5% on the store level in Spain?

That would be excellent. That would be excellent. What I would like to see Apple stores customer because they sell €60,000 per square meter.

I don't know how they're paying their Asian suppliers the iPhones.

Looking for Mercadona, I have a question just about the operations and the Harvard Business School case study which references the quality model where the customer is the boss. Is there anything specific about Mercadona about the operations or the culture that makes them so profitable?

Well, we have already mentioned the merchandise, the relation to supplies, the employees, the store. Well, to me at the end I will not forget about the watch stocks. Juan Roig is a very clever operator and that to me this is one of the threats for the future of the company. For my standpoint no real succession plan.Potentially his daughter. But Juan Roig, he's got a Mercedes van where he has his computers, his printers and everything and he's holding on his meeting and he's never in the office. He's always visiting the stores.

I met him several times never on meetings. I met him at supermarkets, at competitor supermarkets and his own supermarket. He loves his business, he's on top of it all the time so and that's also crucial. It's not only the company that he's running.

What is the relationship between Mercadona and suppliers?

Well, Mercadona the owner, he has his own private equity fund but these guys come over time and yes it is known that the private equity firm is helping their own supplies to escalate. Same guys will found this opportunity here and there. He's also sharing imagine that you have the open book of all the major suppliers in all the categories in Spain, and then you know the factories of everybody.

You have to raise factories which includes regular, I'm not saying they're all the same because but they're not car factories. They're ice cream, or cat food, or detergents and so there are synergies among all of them in order to maximize value, and they do that. They do cross selling with suppliers. I forgot to mention about technology. The digesting data, I saw a picture of him a couple of months ago with the president of SAP the German company. Because he's invested €125 million on technology last year. He's now going into the cloud etc. All his central warehouses to be fully automated and ready to go with Amazon. Technology is a key issue for him as well.

Is there little risk of losing credit insurance for Mercadona's suppliers given this relationship with suppliers?

Mercadona and Discount Food Retail

Current CEO of Future Retail and former CEO of Dinosol Supermercados

inpractise.com/articles/Mercadona-the-most-profitable-food-retailer-in-Europe

Why is this interview interesting?

Executive Bio

Javier Perez de Leza

Current CEO of Future Retail and former CEO of Dinosol Supermercados

Interview Transcript

Related Content

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

Former CEO, Aldi UK

Lidl and Hard Discounter Culture

Former CEO, Lidl UK

Aldi & Lidl Regional Strategy: Adapting to The Local Market

Former CEO, Lidl UK

Lidl in Ireland: from 0 to 12% market share in 20 years

Former Head of Sales Organisation, Lidl Ireland and current Managing Director, McKee's Foods

Audio

Mercadona and Discount Food Retail(December 4, 2019)

PARTNER

Speak to Executive