British grocers struggle as German discounters expand

Tue Apr 8, 2014 7:41am EDT

* Big British grocers pledge 2.4 bln stg of price cuts

* Morrisons sees "paradigm shift" in grocery market

* Discounters 8 pct share of market forecast to double

* Big four's profit margins set to fall

By James Davey

LONDON, April 8 (Reuters) - Britain's major supermarkets are cutting prices but will struggle to stop Aldi and Lidl eating their profits as the German discounters look to double their share of the 170-billion pound ($282 billion) grocery market in the next three years.

Market leader Tesco, Wal-Mart owned Asda and Morrisons have together pledged to make price cuts worth 2.4 billion pounds though analysts question whether they can compete on those terms with the discounters, whose no-frills focus on value won affluent new shoppers in the recession and look set to win more in the fragile recovery.

Sainsbury's, the other member of Britain's big four, has proved to be more resilient to the discounters and has sounded less alarmed by what Morrisons has called a "paradigm shift" in grocery retailing. However, even it will not be immune from broader industry price cuts should they transpire.

As a result, investors will need to get used to shrinking profit margins, especially as food producers and suppliers seem better able than before to defend their own charges and prevent themselves ending up losers in a price war.

In February, Tesco effectively abandoned its target for an operating margin in the British market of 5.2 percent, the highest in the industry. "The margin will be what the margin will be," it said.

With Tesco, Asda and Sainsbury's all operating price matching schemes - guaranteeing not to charge more than rivals for the same product - the scope for contagion is high.

Some analysts question, however, whether waging a price war alone can hold off the rise of the German bargain grocers.

"It's rather like British Airways trying to compete with Ryanair on price," said Ed Garner, director at market researcher Kantar Worldpanel. He reckons a move to slash prices from the big four could reduce profit margins and damage balance sheets but not significantly increase sales.

Forecasting Aldi and Lidl could double their market share, Garner said: "The low-cost element of the low price is so engrained into Aldi and Lidl culture it's quite difficult to emulate that with a different supply chain."

LOWER PRICES

Asda started cutting prices last year, saying it would spend 1 billion pounds over five years, but is yet to see a turnaround in its sales performance.

In February, Tesco said it would spend 200 million pounds on lower prices for basic products and a similar amount on a fuel savings scheme for holders of loyalty cards. Last month, Morrisons said it would invest 1 billion pounds in holding down prices over the next three years.

The big four are also working harder to extol what they have and what the discounters do not, be it more brands, more choice, general merchandise, online shopping, fuel, retail services such as banking and insurance, smarter stores and more staff.

However, Bruno Monteyne, an analyst at Bernstein Research, reckons both Tesco and Morrisons are still struggling to differentiate their offerings, meaning they lose customers both to the discounters and to upmarket grocers Waitrose and Marks & Spencer.

Although Aldi and Lidl still have a fairly small combined share of the British grocery market at 8.0 percent, according to the latest Kantar data on Tuesday, they are seeing growth of 35.3 percent and 17.2 percent respectively, while their bigger rivals struggle to eke out any growth at all.

Shore Capital analyst Clive Black said the big four were dealing with a customer revolt: "People have basically said 'I don't want your promotions, don't trust your price matching and more to the point, I am going to try something else'."

Sally Young, a personal trainer, from Dorking near London, is typical of those switching. "My cleaner told me Lidl was very good," she said. Young tried it, liked the prices for staple goods, such as bread, milk, butter, cheese, salad and fruit and found the quality "generally good". She is now a regular.

Lidl, which opened in 1973 to challenge the older Aldi brand, launched in Britain in 1994 and now trades from about 600 stores in the country. It plans up to 20 openings in 2014 and 20 to 40 a year after that. It is owned by Germany's third-richest man, Dieter Schwarz, son of the founder.

Aldi opened its first British store in 1990 and now trades from 514 stores there. Controlled by Germany's richest man, Karl Albrecht, it has an ongoing plan to open 55 new shops a year.

Both chains have thrived by offering low prices in one of Europe's richest countries, appealing to instincts for thrift. They keep prices down by selling mostly own brand items, bought in bulk and piled high, sometimes still on warehouse pallets. Staff are few and there are no loyalty schemes.

Their international reach has given them considerably buying power, helping them keep down costs.

Together they enjoy market shares of 33 percent in Germany, 24 percent in Austria and 18 percent in Ireland and Belgium - much higher than the 12 percent discounters peaked at in Britain in the 1990s when home-grown budget chains were significant.

FUNDAMENTAL SHIFT

"It's not since the late 1950s and the advent of the supermarket have we seen this sort of change in the market," Morrisons Chief Executive Dalton Philips said last month, as he issued a hefty profit warning.

"This is not cyclical; there's been a fundamental shift in how consumers view discounters. If we don't address it we will continue to lose more. You can see their growth in Europe."

Some, like Sainsbury's Chief Executive Justin King, believe Philips exaggerates the threat because Morrisons is particularly vulnerable to the discounters, given its late entry into fast-growing convenience and online areas. But there is no doubt they are now a major force in the British grocery trade.

More than half of Britain's shoppers now visit discounters and are increasingly using them in the same way they would a traditional supermarket to do a full shop rather than a top-up.

More and more middle-class customers are coming through discounters' doors. Lidl for example says the proportion of its customers from the more affluent "ABC1" and "AB" demographics now stands at 51 percent and 24 percent respectively.

According to data from market researcher Nielsen, Aldi's average basket size of almost 17 items is now more than Sainsbury's and on a par with Morrisons, despite it carrying significantly fewer product lines - about 1,350 versus 30,000-40,000 at the big four.

"People want to, rather than need to, shop at Aldi," the Ruhr-based company said of its British operations.

While the discounters enjoy a price gap versus the big four - for example Aldi typically sells 2.5 kg of potatoes for 1.89 pounds versus 2.00 pounds at Tesco and Asda - the gap between the perception of discounter quality and that of the traditional grocers is closing, according to research group Millward Brown.

That has been helped by the discounters broadening their fresh produce ranges, sourcing more British produce and their promotion of more high-quality products. Quirky television ads have also helped.

Aldi's Easter product range includes whole quails, whole stuffed pheasant and a four-bird roast, while Lidl's includes Aegean sea bass fillets and three-fish roast.

Sainsbury's King, who will leave the grocer after 10 years at the helm in July, appears the most relaxed of the traditional market leaders to the discounters' threat, reflecting the firm's outperformance of its three big rivals in recent years.

He insists he is not complacent but says discounters are simply not a new phenomenon: "Overall it's part of the cut and thrust of the market," he said. "It was ever thus." ($1 = 0.6028 British Pounds) (Additional reporting by Neil Maidment and Emma Thomasson; Editing by Alastair Macdonald)

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