Lidl: Hard Discounter Business Models | In Practise

Lidl: Hard Discounter Business Models

Former CEO, Lidl UK

Learning outcomes

  • The pillars of the hard discounter business model (approach to product assortment, customer value proposition, low cost operating model)
  • Discounter pricing strategy (price positioning vs mainstream retailers)
  • Hard discounters vs mainstream retailers: competitive strategy
  • Aldi & Lidl regional strategy: adapting to the local market
  • Leadership communication in retail: staying close to the front line
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Executive Bio

Ronny Gottschlich

Former CEO, Lidl UK

Ronny spent most of his career with a discount grocery food retailer Lidl, where he worked in various positions from 2000 to 2016. This culminated in the role of CEO for Lidl’s UK business from 2010 to 2016. Lidi’s UK business grew revenue from GBP 2.5bn to over GBP 5bn under Ronny’s leadership, doubling its market share in under five years. He now runs his own retail consultancy business Heunadel. Read more

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Ronny, very briefly, before we dive into your career history and your experience in operating discount retailers, could you tell us a little bit about your background and your career experience?

I’ve worked, throughout my career, for the Schwarz Group. I started in 2000, after I graduated with a degree in business, from an East German university; I’m originally from East Germany, near Leipzig, in a place called Halle. Part of the business of Schwarz Group is Lidl, which some of you may know, which is a discount chain, and Kaufland, a hypermarket chain. They are the biggest retailer in Germany and the fourth biggest retailer in the world. I worked for them from 2000 until the end of 2016. From 2010 until 2016, I was the CEO for the UK operations.

To set the scene, in terms of the pillars of a hard discount business model and, I suppose, we could relate it, specifically, to Lidl, could you take us through, on a strategic level, on an operational level, what really constitutes the core of these businesses?

The discount format is already quite old, if you look at it in terms of how quickly retail and grocery retail is developing. In Germany, it is more than 100 years, since some members of the Aldi family and the Lidl family started. The core and the key difference to the standard retailers, which you maybe know, is that this is a model where you are happy with less range in a store. You are probably dealing with 10% of the normal range of a hypermarket. But the key driver to get customers in, has always been the price message. The discounters are proud of themselves for offering all the products required for weekly or daily needs, but at the lowest price in the market.

One thing which, in my view, has been mistaken in a few countries, was that the assumption was that the products are so cheap because the discounters are selling poor quality. The opposite is the case. The discounters pride themselves on putting very high quality of product – I’m not saying always the top, highest quality – on their shelves, at the lowest price in the market and that allows them, really, the success that they’ve seen, over the last couple of years, in particular.

We have this high volume per SKU model, we have this pillar of attractive value for money, for the customer. To get into a bit more detail on this low SKU count and what that actually does for the model and maybe, how customer understanding has developed? It seems that we’re pushing a lot of sales volume through a very small number of products.

If you take a customer in the UK, 10 years ago, the assumption, aside from the quality assumption, would have been, I cannot do my weekly shop in a Lidl or an Aldi store. The reason was that they don’t have everything. Maybe they don’t have all the brands and the discounters would, usually, stock much fewer brands. They pride themselves on putting the high quality into their private label. 80% is private label. To give an example, I keep asking people how many different types of water do you stock at home? Most people answer, maximum one or two different types of water, which they buy. They have it at home if they don’t drink just tap water. If you look into a hypermarket, you maybe find 40 or 50 different types of water. The same water, from the same brand, sometimes in four or five different sizes, with the yellow top, with the pink top or whatever.

The point is, that the extra space this needs, the extra negotiation, the extra people this requires, in terms of negotiating that. The extra space, not just in the store, but in the warehouse. All of that adds to the cost. If you are not prepared to pay for the choice of someone else, then the discounter says, listen, we have five or six different types of water. We have a sparkling water, we have a lightly sparkling water, and we have a still water. They leave it there and just simply say, this is all you need and, trust me, with those types of water, you will survive, but it’s maybe not the feelgood factor for everyone and maybe not for your neighbor. But if you’re not prepared to pay for your neighbor’s choice, then this is the cheapest way of getting the products, because the discounters are saving on all those little steps I’ve described, on the supply chain, from the negotiations, through the warehouse, into the stores. You can actually put a pallet out of the product, because they are selling so fast, rather than one case of the one-liter pink lid bottle. The discounters are putting a Euro-pallet out and it sells much, much faster and it’s obviously more efficient to put a pallet out, than individual cases. This is a huge cost saving and that adds to the point that they can allow themselves to sell the product so cheaply and by no means, in that instance, are they selling a cheaper quality.

In terms of pricing, this fundamental pillar of being very attractive, in terms of value for money. How does a discounter look at a price gap, versus a mainstream retailer?

Firstly, you would say, the bigger the price gap, the more advantage for the discounter. Full stop. That’s self-explanatory. The discounters would be looking at that, not in a sense of, we need to have that percentage price gap and they just apply that across all the categories, across all the products. It’s rather more, individual product, by individual product. To give you an example, there are commodities, like milk, sugar and flour, where some of the established players, the big four players in the UK, probably only have a price gap of 1% or 2%; sometimes zero. But then, if you apply that across the assortment, you’ll find products where there is, sometimes, a price gap of 20% or 25%. The discounters will really make sure that no one undercuts them, on price. It’s clear that, on some very fast-selling lines, it hurts both types of retailers – the big four retailers, as well as the discounters – as the margins are usually much thinner, on those products. The way the discounters approach that is, obviously, they try to take a look and see, where can I afford, myself, to sell a product, still with profitability and still with a small margin, maybe? They would probably not want to go with the margin higher than 50% on any product – that might be the opposite at some of the big four supermarkets – just simply because they’re saying, we want to be attractive in our pricing and we want to offer the customers real value for money.

If some products are really on such high margins, then they will be living with 30% or 40% or something like that, but not trying to improve that to 80% or 100%.

You have direct experience, over a number of years, in the UK market. How has that price gap evolved, over the years? In particular, during your leadership of Lidl’s UK business?

That price gap goes up and goes down. But I think, as a trend, it’s fair to say that the price gap has narrowed. If you were to take it back 15 years, then the price gap was about 20% to 25%, on an average basket, probably. These days, I would argue it’s only around about, maybe, 10% to 12%, on an average basket. Again, that’s not on every product. That’s a weighted average basket of weekly shopping. But you can see the pressure has been increasing, from the big four. I think they’ve realized that the price gap, for too long, was allowed to be at that level. Maybe, for too long, some of the established players have been living with too high dividends and too high earnings. That’s just meant that the long-term perspective was closing and has caused them quite some pain.

I’ve seen some of the retailers really fighting back on that one, with private label, but also price investment. That meant that the price gaps narrowed. Saying that, I feel as if there is not much more room to be made, from a big four point of view, in reducing that margin further, if they want to stick to their usual shareholder value for money proposition. I believe, they could narrow that margin down to zero; it would not be an issue. At zero, I feel that they would be loss-making. But let’s say they were to bring that down to, maybe, 5% or 8%, which would put them within striking distance, then maybe the profitability, the bottom-line, net result, for some of the established players would not be 3%, 3.5% anymore, but rather 1% or 1.5%, if anything.

At the EBITDA level?

No. That would be on the net bottom-line result.

Maybe just building off what you’ve just said, in the evolution of this market and the response that’s typical of incumbents, when a discounter comes into the market and seems to grow from a very small base, off the radar, to an explosive market presence. In the UK, I think, we’ve seen 6%, 7% market share increase, for the discount channel, just over the last five or six years. We’ve seen this happen time and time again, across markets, that Aldi and Lidl enter. They are ignored, they’re described as irrelevant by the incumbents and within a matter of years, it’s all anyone can talk about, especially on the downside, for the shareholders of incumbent retailers. Why is it that incumbents keep missing this, across markets, where this playbook has been executed on, time and time again, by the discounters?

I’ve been thinking long and hard about why they do it? It’s not such a difficult exercise. One answer I’ve come up with is the ownership structure. The discounters and many of the German retailers are in, let’s call it, private ownership; the discounters, in particular, Aldi and Lidl, are. The other discounters are partially privately owned. None of those retailers are publicly owned and in many shareholder’s hands. Many shareholder’s hands mean that many people have different interests. Many people want to get a high return on their investment into that retailer.

There were times when some of the big four retailers got those bottom-line results of 5% or 6% on those lines. Of course, if you, as an investor, as small as you may be, get used to those kind of returns, it would be difficult to say, at some point, we need to be happy, for the next five or 10 years, with only 1% or 2%. But that difference is what would be needed to fight off the price investment with investment into your store portfolio, capex, etc. to make sure that you don’t allow the discounters, early on, to start breathing.

This is a machine and if this machine, the discounters, start rolling, it is a very, very expensive way to figh them off. In the instance of the UK, I believe it’s too late. They’ve reached a critical mass of about 500 stores each. For every store they open now, their fixed costs, if you were to take the headquarters, they don’t need additional people anymore. This is just adding to their profitability now. I’m not saying that they are always, constantly profitable, because the pound exchange rate is causing headaches, as well. But you have to say, back to your question, fight them early on, if they were to enter the market. Do not ignore them. I think it’s just that game of, if you’ve seen that a retailer is really successful somewhere else, take them seriously, very early on and do not ignore them just because they only have 10, 20, 50 stores. Fight them and take them seriously, as if they already had 1,000 stores. I think that would have to be the lesson.

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Lidl: Hard Discounter Business Models

May 1, 2020

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