Hard discount - Hey Small Spender

Once the poor relation of the retail industry, hard discount is now worth approximately t100bn a year worldwide. And while personal care's share may be small, it nonetheless represents a sizeable turnover – and it's growing. ECM looks at the implications for the C&T industry.

While many retail formats have found things tough in recent years and have tried to alter their positioning to draw in consumers, there's one that has managed to stay true to its business model and grow its sales. Hard discount stores may have a decidedly unglamorous image, but their combined sales are hardly shabby.

In fact, the image of hard discounters as the preserve of low income families is not just outdated, says Jean-Jacques Vandenheede, AC Nielsen's retail services director, it's a misconception too. “Hard discount has nothing to do with price,” he argues. “It's about proximity.” As an illustration of this proximity, Vandenheede points to the fact that 47% of Germans live within a kilometre of a hard discount store – almost walking distance. The same thing is happening in Austria, the Netherlands and Belgium.

The common element of these countries is that they represent mature, highly developed consumer markets. Contrary to expectation, this is an essential part of the mix for hard discounters. Up to 80% of hard discounters' business comes from Europe, the vast majority of which is based in EU member states. Vandenheede says that it's notable that there are no hard discounters active in developing countries such as China, India and Russia. Nor are there likely to be until these markets show signs of maturity.

That's because of the second phenomenon governing hard discounters' popularity. Their business model only works where product categories have become so commoditised that brands are relatively unimportant and price is the only differentiator. So, while hard discounters may have a slightly different image in every country of operation, generally speaking they offer a fairly limited assortment of products, represented by perhaps one or two brands each. As a result, the stores are relatively limited in size, rarely covering more than 1,000sq m. The brands themselves are rarely well known and tend to be the stores' own labels, albeit marketed under a different name.

Hard heads

While companies such as Carrefour claim to be hard discounters in France, there are really only two major companies that conform to the classic model. Aldi and Lidl are two highly secretive, privately held German companies which between them account for perhaps as much as 90% of global hard discount sales. Of the two, Aldi is the larger and follows the classic hard discount model, stocking only 700 items compared to the 25,000 products provided by many supermarkets.

Aldi was founded in 1946 by brothers Karl and Theo Paul Albrecht in Essen, Germany. In 1961 the Aldi chain split into Aldi Nord and Aldi Süd over a dispute whether to sell tobacco products. Although the two share only a name and a corporate identity, in practice they describe their relationship as a 'friendly alliance' and do not compete directly with each other. In fact, Germany is the only country where both are present. Aldi Nord operates in Northern Germany, the Benelux countries, Denmark, France, Portugal and Spain. Aldi Süd is present in Southern Germany, Australia, Austria and Slovenia (as Hofer), Ireland, Switzerland, the UK and the USA.

In the last decades Aldi has moved away from the classic groceries and household goods assortment to embrace other FMCG categories. Industry expert Dieter Brandes said in a recent interview that he estimated Aldi’s German operations to generate a fifth of its turnover through non-food goods. The company also recently started offering pre-paid mobile phone services.

In all Aldi has approximately 7,500 stores and reportedly saw sales of £34bn in 2003, making it the 12th largest retailer in the world.

However, Aldi, along with all hard discounters, is beginning to face a problem when it comes to growth, as Vandenheede explains: “Hard discount stores reach a plateau very quickly when it comes to organic growth. The sector is consistently growing at 5-10% in most countries, at least where the markets are relatively flat, but this growth depends largely on new store openings.” It’s hardly surprising, therefore, that both Aldi and Lidl’s websites loudly proclaim that they are looking for new store sites and offer generous commissions in return for introductions.

In France, for example, the hard discount is highly competitive and is seeing its growth slow considerably. In 2005, hard discount market share of French retail grew just 0.1 percentage point to 13.3%, according to Taylor Nelson Sofres Worldpanel, and so far this year shows signs of falling to 12.8%. It's a similar situation in Germany. Aldi's store density is at its highest here, and the company saw its sales fall by 0.6% in the first half of 2005, according to GfK.

The slide is due to a fightback from the supermakets and hypermarkets which have branched out into value own label lines and special offers of branded goods. But hard discounters are confident that they can return to growth. “Those who predict the end of discounting in France are very much mistaken,” said Jean-Charles Naouri, chief executive of Casino, announcing the company's 2005 earnings in March. Naouri pointed to the fact that Casino's Leader Price hard discount chain has operating costs of 13% of sales and a margin of 8%, compared to hypermarkets' operating costs of 25% of sales and margins of just 2-3%. “You don't have to do too much reasoning to see which one is stronger, and which resists better in a difficult environment,” he continued.

Lidl is still much smaller than Aldi, but it is growing much faster as a result of its greater agility. The company traces its history back to the 1930s when Josef Schwarz bought into Südfrüchte Grosshandel Lidl & Co, a fruit wholesaler. Under his son, Dieter, Lidl & Schwarz began to focus on discount markets and opened the first Lidl store in 1973, copying the Aldi concept. Since then, Lidl has built up a chain of some 5,500 stores in 18 European countries, which together generate approximately €23bn of sales. By 2010, analysts expect this to grow to €30bn.

And while Aldi’s sales were falling in Germany, Lidl’s grew 13% in the same period and the company has seen growth in Europe average out at approximately 17% per year. This is largely due to Lidl’s hectic store opening, which far outpaces that of Aldi. Lidl currently makes more than half of its turnover outside Germany, and the company is said to be planning moves into Canada, Croatia, Estonia, Latvia, Lithuania, Romania, Slovenia, Switzerland and, most recently, Bulgaria. That’s because it achieves a higher return on sales overseas than it does in its price-pressured home market.

However, Lidl’s fast growth is also down to its modification of the hard discount model. Its stores tend to be larger than Aldi’s, have longer opening hours and carry more product lines – as many as 1,200 in the UK. But the key difference is that Lidl stocks branded items as well as its own label products. Analysts say that the company operates a short-volume, WIGIG (when it’s gone it’s gone) policy when it comes to these brands, and while they are chiefly in the grocery and household product sectors, some personal care brands are coming on board too.

Personal favours

There are clear signs that manufacturers are starting to treat the hard discounters as normal retail outlets in a bid to reach out to their shoppers. Pricing considerations have led some manufacturers to create smaller packs or special formulations for the particular market, but others merely try to keep prices within acceptable boundaries. One such manufacturer is Beiersdorf, which signed a deal at the end of 2005 to quadruple its product range in German Lidl stores. These will jostle for space with an array of own label products, including toiletries, make-up, even fragrances, which bear a marked resemblance to their branded counterparts but at a fraction of the price.

Another discount chain, Netto, has gone further along this route, allocating as much as 20% of its shelf space to branded goods. Unilever has bought into this proposition, allowing Netto to stock its Dove and Lynx products. Gillette also sells its shaving products through Netto.

Lidl’s rapid growth has prompted Aldi to look at its own approach to brands. The chain currently sells its own label personal care brands such as the Siana facial skin and body care line, its Fruit and Herbal Extracts hair care range, bathroom products and men’s toiletries under the Excite and Rainforest banners, and a number of deodorant lines. However, its tip-toe introduction of grocery brands indicates that personal care brands cannot be far behind.

That’s because, as Vandenheede says, there is a limit to the role the stores’ own label brands can play in personal care. “That’s because the commoditisation of these categories is minimal. People still care about their personal care brands. As long as manufacturers are still delivering on their promises to consumers and commoditisation is kept low, there’s little room for hard discounters’ brands in the market.”

But with Aldi and Lidl moving into a more multi-format offer, introducing value-added items such as baby food and organic produce, and Asda opening its own discount outlets in the UK, there is a clear opportunity for more value-added personal care lines too. The key for brands is thus to make it into these stores in sufficient quantities to withstand the competition of such own labels. For contract manufacturers, the prize is to win hard discount accounts and carve out sufficient margins too.