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Are U.S. Grocers Headed for a Price War?

Jun 16, 2017
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SMITH BRAIN TRUST – The U.S. grocery industry is bracing for a shakeup – and a potential price war – as one German supermarket chain seeks to make its debut and another looks to expand its reach.

German grocery chain Aldi says it will invest $3.4 billion to broaden its U.S. footprint, adding 900 new stores by 2022 and remodeling 1,300 others. German rival Lidl, meanwhile, is opening its first U.S. stores this month, with plans to open 100 by next summer.

The added competition in the low-margin world of grocery retailing comes as food prices for the U.S. are under pressure, falling for 17 straight months. It's the longest stretch without an increase in more than 60 years, according to Bloomberg.

And it comes at a time of continued price-sensitivity for many Americans.

Both Aldi and Lidl operate on a hard-discount business model. They use highly efficient supply chain and logistic systems, offer a fairly limited assortment that's dominated by store brands, and operate smaller physical stores in a "no-frills fashion," says Jie Zhang, professor of marketing and the Harvey Sanders Fellow of Retail Management at the University of Maryland's Robert H. Smith School of Business.

That allows them to contain costs and keep retail prices low, while still making good profits. And Aldi, Zhang notes, is the world leader in this segment.

Aldi's expansion and Lidl's arrival are likely to have grocery chains, particularly those that target lower-income consumers, feeling the pinch. On the national level, that means Walmart and Target, and on the regional level, it means Food Lion, Cub's Food, and ShopRite, among others.

Large domestic discount retailers, notably Walmart and Target, have tried to win over those shoppers. But, Zhang says, they've been hampered by their large-store format, real estate constraints and higher labor costs of urban areas. The chain that has been successful in those areas is Dollar General, which doesn't carry many food items, but does boast similar average square footage to an Aldi or a Lidl.

That gives Aldi and Lidl a "huge market potential to tap into," Zhang says.

"Mid-tier supermarket chains, especially those in urban areas, need to watch out," Zhang adds. "Aldi and Lidl can make a big dent on their businesses if they don't react swiftly and strategically."

And that could result in a grocery price war, says Oliver Schlake, clinical professor of management and organization at the Smith School.

The U.S. grocery retail industry is highly competitive, Zhang notes, and not easy for a newcomer. Several big international players have attempted to grab the market but failed, including Carrefour and Tesco.

"Aldi has been an exception though," Zhang notes. "Since entering the U.S. in 1976 with its hard-discounting format, it has steadily expanded to 35 states, because of its unique and successful business model."

Aldi now has 1,600 stores across the U.S. and 418 of its Trader Joe's stores, which debuted in the U.S. in 1979.

European chocolates

Schlake, who grew up in Germany, has been shopping at Aldi since he was a boy of about 9, trailing his mom on shopping trips.

"Aldi has very interesting in-house brands," says Schlake, who after 40 years remains an Aldi devotee. "It's filled with items that are produced by the big-brand-producers, but that are not sold under the main labels, in order to protect those brands."

In recent years, Aldi has aggressively expanded its organic offerings and specialty products.

For Schlake, part of the allure of his Northern Virginia Aldi store is the steady supply of real European chocolate bars. "My breakfast this morning," he says, "was three pieces of real German chocolate, which I bought at Aldi."

Now might be the perfect time for Lidl's entrance and Aldi's expansion, Zhang notes.

Although the overall U.S. economy has rebounded, the recovery has not been as robust among lower-income households. "I think the timing is good for discount grocery chains," she says.

Aldi already has been successful in the U.S., serving low-income urban markets, the same market Lidl tends to target. "This is a large and underserved market that has been missed out by most retailers in the U.S.," Zhang says.

Lidl, she adds, "has a decent chance to be successful" in the U.S., as it has been in other countries. But it will have to compete here with its familiar rival, the already established Aldi.

Shopping carts for rent

The Aldi shopping experience isn't much like the traditional American supermarket, however. You won't find hundreds of different cookie or cereal options at an Aldi.

"You also have to be flexible when it comes to your brand choice," Schlake says. "They carry toothpaste, but they aren't carrying 860 different kinds of toothpaste. If you like it, you buy it. It's not your favorite? OK, well, then you buy your toothpaste somewhere else."

The limited portfolio of items simplifies the supply chain, and the reordering and restocking process.

"In Germany, when you shop at Aldi, you are used to no-frills," Schlake says. Customers at both Lidl and Aldi are required to bag their own groceries. Shopping carts are equipped with a coin slot that allows customers to "rent" the cart for about 25 cents while they shop. Shoppers get their quarters back when they return the carts. It keeps the carts from becoming scattered all over the parking lots, minimizing staff hours needed to corral them and return them to the stores.

"They are very aggressive on keeping costs down," Schlake says.

Of course, Aldi's appeal won't be limited to shoppers at the lower end of the income spectrum and not all of its stores will be in low-income areas. Through the years, Schlake says, he's noticed Aldi's rising respectability among all classes of people.

"It used to be that if you shopped at Aldi, you didn't want to tell people that you shopped at Aldi, but they have really overcome that now," he says. "And now you see the duality of people who are driving a Porsche and then going to Aldi. People over the years have realized, hey, it's a good deal."

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The Robert H. Smith School of Business is an internationally recognized leader in management education and research. One of 12 colleges and schools at the University of Maryland, College Park, the Smith School offers undergraduate, full-time and part-time MBA, executive MBA, online MBA, specialty master's, PhD and executive education programs, as well as outreach services to the corporate community. The school offers its degree, custom and certification programs in learning locations in North America and Asia.