The grocery industry in many countries has been disrupted by a new kind of grocery store called a hard discounter.

When grocery shopping, we’re used to seeing the home brands. These are the budget-focused brands such as Pams, Budget and Essentials etc.

These brands are owned by the supermarkets and they are an attempt to offer a product at a lower price point than the usual big brand name products.

These have been the cheapest brands available.

But when a hard discounter enters a market they drop the prices even lower than the existing home brands.

The two common hard discounters are Aldi and Lidl. They are both German companies who have seen quite rapid expansion over the past 20 years.

I always assumed these hard discounters would be simply selling lower quality products like the home brands we see in NZ supermarkets. But that’s not the case at all.

A UK study compared the quality of these products and found that the hard discounters were of the same quality or better than the leading branded products. 

For example. Fruit Muesli bars were compared. The expensive branded product had 45% fruit, Lidl had 50% fruit and the budget brand had 7-10% fruit.

Tomato Ketchup, the branded product contained 148g tomatoes/100g, Lidl 185g tomatoes/100g and the budget brand 81g tomatoes/100g.

So how do these companies offer the same or better quality groceries at lower prices than the existing supermarkets?

I came across a book by Jan-Benedict Steenkamp called Retail Disruptors. Steenkamp and his team have looked into this subject in great detail. 

The first noticeable difference between hard discounters is they reduce the number of products they sell. Instead of having 7 tomato sauce products a hard discounter may have just two. This means a hard discounter is ordering higher volumes of fewer products.

Supermarkets refer to products as SKU or stock-keeping units. 

To understand why this is an advantage, it’s interesting to look at the Dutch supermarket chain Albert Heijn. In 2017 they had a 35% market share and revenue of 13 Billion euro. Aldi, on the other hand, only had a 7% market share and a revenue of 2.5 billion euro.

Albert Heijn had 950 stores and 27,500 SKU. This equates to revenue of 0.5 million euro per SKU.

Aldi had 500 stores and only 1,250 SKU. This means Aldi revenue was 2 million euro per SKU. 

On a per-store basis, Aldi revenue was 4,000 euro per SKU/store compared to Albert Heijn 500 euro per SKU per store.

These hard discounters are actually making much greater revenue per SKU. Their stores are also much smaller so they are more profitable on a revenue per square metre basis too.

The reduction of product range simplifies the ordering, delivery, warehousing and stocking of shelves. So they also have a lower staff number too.

Cost of goods sold is the price that the supermarkets pay for the products they sell. For most supermarkets, the cost of goods sold is 75%. This means that for every dollar they sell 75 cents goes to the suppliers.

These hard discounters have a cost of goods sold of only 50%. This much lower procurement cost combined with their higher revenue per SKU makes them quite profitable businesses.

They tend to form long term relationships with suppliers too. Once the price has been agreed they don’t try to renegotiate or try a squeeze the supplier with any backhanded tactics. They pay on time and keep the relationship going long term.

But the dramatically lower cost of goods sold means they are really pushing their suppliers to the limit.

This is the real concern as farmers and growers are not compensated adequately for their products as it is. There is plenty of evidence that the suppliers of these hard discounters struggle to stay viable.

I’m not sure if hard discounters are a good thing. But the most interesting aspect of these hard discounters is how the traditional supermarkets react. The usual response is they start offing a comparable product to the hard discounter. The problem they have is their existing customers switch from their higher-margin branded products to the new lower-margin products. 

The supermarket’s margin then drops. These supermarkets still have a higher cost structure associated with higher levels of SKU, staff and stores needed to be a higher margin retailer.

The supermarkets are essentially trying to be branded higher-margin businesses while also trying to be a discount retailer at the same time. It’s a compromise that is difficult to execute.

The hard discounter has one goal and vision and they put everything into being really good at just one thing. That’s quite a powerful concept.