Why U.S. Grocery Chains Need More (and Better) Store-Brand Products

The U.S. grocery industry has reached an interesting and uncertain crossroads. In 2017, German discount grocery retailers ALDI and LIDL announced plans to open hundreds of new stores across the United States. ALDI plans to open 900 stores by 2022 and LIDL to open 100 by the end of 2019. Also in 2017, online retail giant Amazon bought Whole Foods, and has been rolling out a series of experiments in ordering, pricing, and delivery in stores across the country. And trends like meal kits, farm shares, and app-based ordering and delivery have added further wrinkles for incumbent grocers to contend with.

While these latter developments — Amazon/Whole Foods, app-based ordering, and meal kits — have gotten a lot of attention from the business press, we think that the popular business press has not given enough attention to the incursion by Aldi and Lidl into the U.S. market.

One does not have to look very far to recognize the threat posed to competitors like Walmart, Target, Costco, and Kroger by the German hard discounters. The UK grocery market shows what could happen: ALDI and LIDL have 13.1% market share in the UK today, having grown more than 50% over the last five years. All four of Britain’s biggest grocers — Tesco, Sainsbury’s, Asda and Morrisons — now collectively account for 68.5 per cent of the UK grocery market, which is down from 76.3 per cent just five years ago.

Will U.S. grocers fare any better? The answer may lie in whether they learn from the experience of the French grocers. In France, hard discounters have 12% share of the grocery market just as they do in the UK. However, in the UK, the market share of ALDI and LIDL is expected to continue to grow, whereas in France, it’s already declining — back in 2009, hard discounters held a 14.9% market share in the country.

How did smaller French retailers fight them off? Through the savvy use of private-label products (also called white-label goods or store-brand products).

Private-label products are essential to the profit margins of hard discounters. A hard discounter usually sells about 90% private-label goods, whereas a regular grocery store sells about 51% of private-label goods in the UK, 34% in France, and 15% in the U.S. Moreover, hard discounters sell a narrower range of products — usually about 2,000 SKUs, compared with 30-40,000 in a traditional supermarket, or 100,000 at a Wal-Mart supercenter. The advantage this gives a hard discounter is three-fold: cheap products, good quality, and customer convenience — a shopper can get what they need in under 30 minutes. The downsides are that there is less choice of products, little customer service to speak of, and less-attractive stores and displays. But customers can get good quality products at lower prices, and products move quickly — by carefully choosing which products to offer, stores don’t have a lot of goods just taking up space on the shelves. Hard discounters win by only stocking products with a very high rotation.

To fight back against the hard discounters, French grocers realized they would have to improve their use of private-label products. While branded goods had always been essential to their profit margins, they realized they had to beat the hard discounters at their own game. This meant that they had to cut prices on private-label goods while improving their quality — not an easy task. By offering affordable goods of reasonable quality, French supermarkets have been able to regain market share.

In the UK, grocers had long relied on private-label goods to support their profit margins and differentiate themselves from competitors. This implied good quality private-label goods at attractive prices. To compete with the hard discounters, they decided to introduce a tiered approach to private-label products: high-quality goods at premium prices, standard goods at middling prices, and low-quality goods at budget prices. The new budget offerings are very cheap indeed; often cheaper than anything you can find at Aldi or Lidl. But to be able to offer these very cheap products, the UK supermarkets had to cut quality beyond what shoppers would tolerate. Shoppers have not been happy about this, preferring to pay a bit more at Aldi or Lidl and get great low prices and reasonable quality. The result has been eroding market share for incumbent grocers.

In the U.S., the road ahead for established supermarkets will be difficult. U.S. retailers are far behind in terms of their private-label product offerings, which will be a huge challenge in the fight against Aldi and Lidl. Again, about 90% of the products sold by hard discounters are private label; in U.S. supermarkets, only about 14.5% of sales are private-label goods. (Whole Foods is a notable exception — their strength in private-label goods is one reason that they were an appealing target for Amazon, which is increasingly interested in private-label items.) With share of sales comes experience and expertise. To catch up, U.S. grocers will have to quickly make up for lost time.

U.S. supermarkets will have to offer private-label goods of the “right” quality at the “right” price to fight the hard discounters. To do that, they will need to first find suppliers that can deliver affordable products without sacrificing quality. This will only be possible if the U.S. grocers can guarantee enough volume to these suppliers so that they can make the right investments. To boost the volume of private-label sales, supermarkets will have to change the way they display, promote, and merchandise private-label goods. They will also have to commit to this private label strategy in an increasingly uncertain food retail business.

The experience of French grocers shows that it’s not impossible to beat hard discounters at their own game. But it also is noteworthy that France’s experience is the exception, not the rule.