US grocers count the pennies as discounters wage price war
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In Fredericksburg, Virginia, German retailers are trying to beat Walmart at its own game. At stake is the $800bn US food market, in a battle being fought over a few cents on the prices of eggs and cereal.
Discount chains Lidl and Aldi are hoping to replicate the success they have enjoyed in Europe and the UK, where their no-frills approach and low prices have helped them capture 12 per cent of the UK market, a share analysts expect to rise eventually to a quarter.
Lidl has been quietly crafting ideas to test US appetites for more than a year, building a prototype store in Fredericksburg, before opening its first US store in June — just as Amazon unveiled its $14bn deal to buy Whole Foods. Grocers across the US and Europe had $40bn wiped from their market value as investors contemplated a deepening price war in an industry grappling with historic food deflation, falling revenues and pressure on already thin margins.
Lidl’s US debut had been widely anticipated. “I’ve been researching Lidl for a decade,” says the chief executive of one large US grocer, while Aldi, which has operated in the US for 41 years, has also been bracing for the launch by revampingits1,600 US stores.
Bryan Roberts, director at consultancy TCC Global, says the US food retail market is about a decade behind the UK, where a price war has been raging for several years and the big four grocers have had their share eroded and margins squeezed as Aldi and Lidl lure shoppers.
In the US, food prices registered their first annual drop in nearly 50 years in 2016 — the result of lower oil and grain prices, which was only exacerbated by aggressive discounting. Kroger, the second-largest US grocer, in March reported its first quarterly revenue decline in 13 years, citing food price deflation as the “primary driver”.
In Fredericksburg, neighbourhood supermarkets are being undercut as grocers battle over penny savings. Recently at Giant, a 70-year-old chain, a box of Cheerios cereal was selling for $2.99, but the Walmart two miles down the road offered it for $2.98. Walmart charged 54 cents for a dozen eggs, but Aldi was charging 53 cents.
“Even a one or two point difference in perceived prices can be worth hundreds of millions of dollars in sales or margin,” say analysts at Bain. But they warn that “as pressure intensifies to reduce prices . . . grocers may act hastily”.
Lidl has opened 37 stores in Virginia, the Carolinas and Georgia, and plans to have 100 stores along the east coast by next summer. Aldi has said it will spend $3.4bn to add 900 US outlets in the next five years and a further $1.6bn on renovating existing stores.
Bain predicts that discounters’ revenues will rise 8 to 10 per cent through to 2020, five times faster than traditional US grocers — growth that will be aided as stagnant wages push frugal shoppers to cut-price retailers. Aldi’s expansion plan would make it the third-largest chain by number of stores, and Kantar Retail projects Lidl will generate nearly $9bn in sales from the US by 2023 — though still far from Kroger’s $118bn revenues last year.
While the biggest chains such as Walmart, America’s largest grocer, should be able to weather the storm, analysts expect consolidation, bankruptcies and store closures among smaller regional groups.
“In these towns . . . you typically go to your nearest store unless it’s truly woeful,” says Mr Roberts. “The discounters open stores sufficiently close so that it’s worth driving past that incredibly average supermarket you’ve been driving past for the last decade. They are the ones hit the most by the discounters.”
Analysts have speculated that Kroger or Sprouts could be the next targets. Shares in Kroger jumped on reports that Ahold Delhaize was eyeing a bid for the grocer, while Sprouts Farmers Market, an Arizona-based chain with more than 275 stores, has also been rumoured after it was courted earlier in the year by Albertsons. Sprouts, a high-end grocer that has been likened to Whole Foods, reported revenues rose 15 per cent year on year to $1.28bn in its second quarter to July 2 with same-store sales up 1.4 per cent.
Beyond price, Lidl has been tinkering with its strategy to win over Americans unfamiliar with its no-frills model. While Aldi’s stores are about the same size worldwide, Lidl has opted to make its US supermarkets about a third larger than in Europe. Still, Aldi and Lidl stores are noticeably smaller than other US supermarkets.
Fredericksburg’s 140,000 sq ft Walmart supercentre offers a comprehensive if not confusing shopping experience. Dozens of aisles of snacks, fresh produce and meats sit alongside a hair salon, tyre repair centre and a pharmacy. The nearby Aldi has only five aisles. “What you see is what you get here,” a woman told her partner while pointing to a shelf of pastas at Aldi, where a 32oz package of spaghetti cost $1.09, compared with $1.48 at Walmart.
Mr Roberts says this size difference could help give Lidl a boost in the US, where sprawling supermarkets are the norm. “Walmart is equally competitive on pricing. But the shopping trip is not just about money. [Aldi and Lidl] offer a quick and efficient trip,” he says. “You’re not wasting minutes of your life agonising between 30 different types of ketchup.”
Scott Patton, Aldi’s vice-president of corporate buying in the US, says American shoppers want a “simple, cleaner look” in the store and “they want to identify the price easily”.
The bruising damage of the price war has been clear in the quarterly earnings statements of the largest US food retailers, squeezing profits across a sector that is known for thin margins. Operating profits across US supermarkets fell about 5 per cent last year, according to Moody’s. Albertson’s, which operates more than 2,000 stores under brands including Safeway, recorded a net loss of $131m in the year to February 25. Target, meanwhile, has warned that it will sacrifice $1bn of profit margin this year as it cuts prices on certain products.
For grocers such as Kroger, “the intensely competitive pricing environment makes it very difficult to pass on any price increases to customers, which in turn continues to pressure margins and profitability”, says Mickey Chadha, vice-president at Moody’s.
Kroger’s return to sales growth during the second quarter was overshadowed by an 8 per cent drop in profits, as aggressive discounting shaved 30 basis points off its gross margin.
Walmart, which makes more than half of its $480bn in annual sales from food and beverages, has also opted to cut prices. In the quarter to the end of July, its US grocery sales grew at their fastest pace in five years — but like Kroger, the strategy has hit profits, with gross margins falling 11 basis points to 25 per cent.
Wealthiest consumers defect to Whole Foods
The day Amazon closed its $14bn purchase of Whole Foods, the ecommerce juggernaut began cutting prices at the upmarket food chain — a sign that Jeff Bezos would bring his competitive streak straight to the grocery sector.
The strategy has somewhat paid off, according to new data. Foot traffic to Whole Foods jumped 17 per cent the week of the price cuts, according to data provider Thasos Group. Three weeks later, it had fallen back but remained about 4 per cent higher.
Regular customers of Walmart were the biggest defectors, making up 24 per cent of the new shoppers at Whole Foods, followed by those from Kroger’s at 16 per cent, said Thasos, which tracks geolocation data from mobile phones for hedge fund clients.
Thasos said it was “the wealthiest regular customers” of rivals who had defected, meaning Amazon’s price cuts did not lure lower-income shoppers, a key customer base for Walmart.
A reputation for charging high prices was one of the biggest obstacles for Whole Foods as it tried to revive sales growth, and Amazon has promised there is “more to come” in price cuts. Whole Foods, dubbed “whole pay-cheque” because of its high prices, has reported falling same-store sales for almost two years.
Amazon’s price cuts are a reminder that its leap into food retail “is going to hurt a little, at the very least”, as US food prices have steadily dropped in the past year, says Paul Beswick from Oliver Wyman.
Having watched Amazon upend sectors from bookstores to cloud computing and film, investors have reacted by marking down the shares of bricks-and-mortar grocery rivals across the US and Europe, even as Whole Foods has a relatively small presence in the UK.
Since the Whole Foods deal was announced, Kroger has shed 33 per cent of its market value, while Sprouts has lost 27 per cent.
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