America Should Get Ready for a Grocery Price War

Aldi plans to spend $3.4 billion to add or renovate stores in the United States while Lidl has begun opening its first stores here.

Both chains offer limited selections and low prices. Their expansion into the U.S. has been noticed by major players like Wal-Mart (WMT -0.49%), which has made efforts to bring its own prices down.

On this episode of Industry Focus: Consumer Goods, host Vincent Shen is joined by Motley Fool contributor Daniel Kline to go through how the two companies are tackling the U.S. and what it means for American shoppers. They also examine what makes these chains different compared to traditional full-size supermarkets.

A full transcript follows the video.

This podcast was recorded on June 13, 2017.   

Vincent Shen: The news is Aldi is spending about $3.4 billion to expand its store network, hit about 2,500 locations over the next five years. The company currently has about 1,600 stores. They will add 400 in 2017, and it well spend another $1.6 billion to remodel a significant number of them. On top of that, to throw another player into this, fellow German low-cost competitor Lidl will be opening its stores this month, June 15th, as it plans an initial base of 100 locations. The first ones are opening up in the Carolinas and Virginia. These are definitely some first shots in that price war that I mentioned among the grocery stores and supermarkets. Lidl has touted prices up to 50% lower than competitors. Aldi says they will be at least 21% lower. Do you think that the entry of these companies and the expansion of some of these German competitors is going to really shake things up like they've managed to do in Europe?

Daniel Kline: I think it's great for the American consumer on a number of levels. There's already been pricing pressure in the grocery game, because you have Amazon and other players who can deliver you some items, if not all items in certain markets. But Wal-Mart has already come out and said it's going to invest in pricing. Costco, when they raised their membership fees, said, "We're going to put most of this increase back into lowering pricing," which is what they have traditionally done, it's not necessarily a response here. But if you are in a market -- and I live in Southern Florida, we have Publix. Pretty much that's all we have. There's a lot of Publix, there's occasionally a Whole Foods, and sometimes there's a Trader Joe's. There isn't a Trader Joe's near me. If a Lidl or an Aldi comes in and it's conveniently located in the same realm as the Publix, Publix is going to have to go, "OK, my prices, I have to think about that." So, just the presence of competition is great for consumers.

The other really important thing about this, and it's partly why these companies are moving now, is that we have a glut of available retail space. So these companies -- and these are small stores, 12,000 to 20,000 square foot stores between the two chains -- they're going to snap up space in strip malls and malls that needs to be filled. And that's going to be good for other businesses. Even some businesses that are doing well, but are being hurt by the fact that, maybe the Sears that anchored their strip mall went out of business. So there's going to be a ripple effect by all these stores coming in.

Shen: Dan, I would like to add a little bit of detail on exactly how these companies operate, so that they're able to offer such competitive pricing. 

Kline: A lot of house brands.

Shen: Exactly. When it comes down to it, for a place like Aldi, to put up these prices where they can claim, "Our prices will be at least 21% lower than any competitor out there," the first thing is what you mentioned in terms of the smaller stores -- 12,000 to 20,000 square feet, versus a traditional Kroger or Harris Teeter, for example, might be around 50,000 square feet or more. The smaller stores means less SKUs, which are essentially, the stock keeping units, or the code, assigned to each item. That gives you a small footprint, it's less of an investment there, and also just a simpler supply chain with these in-house brands which, for Aldi, make up about 90% of their merchandise. This allows the company to work directly with the food producers, and they avoid a lot of the costs of marketing, and also the premium that you get that you have to pay for the big branded products out there when you have these in-house offerings.

Kline: It's also a varied merchandise. When you go to Publix, obviously there's a certain amount of seasonal merchandise. When Valentine's Day is coming up, they're going to have a Valentine's Day section, and that switches to Mother's Day when it's appropriate. But both Aldi and Lidl do things like sell flip flops when it's going to be summer, in a market where that's appropriate. And even their core food offering changes based on pricing. I've often joked that you can't go to Aldi knowing what you plan to make for dinner. You have to go to Aldi and see what they have, and then make your choices, which I have always found is a frustrating shopping experience. But that's how they drive value. If their buyer looks at the chain and says, "I was going to bring in lamb this week, but the prices are too high," they may not have that on their shelves at a given time, and you sort of have to go with the flow, but it does mean you're always going to get a better value.

Shen: Wrapping up a little bit of our discussion, I want to provide a little bit of context here, for what exactly this market looks like, what Aldi and Lidl are diving into, and what the competition and the size and scale of this market is. For U.S. grocery food and beverage industry, we're looking at hundreds of billions of dollars, about $800 billion. At this point, even with its 1,600 locations, reports I could find put Aldi share at single digits, low single digits at that. But it's growing very quickly, whereas if you go to the leader of the pack, which is Wal-Mart, they have closer to about a 20% share of the groceries business in this country. I was speaking to Sarah Priestley, another analyst here at The Motley Fool, before the show, and she brought up an interesting point in that, at this moment, especially with Lidl's entry this month into the market as well, I think a lot of American grocery chains, she mentioned, are getting the warning signs because Aldi and Lidl have made such a big splash in Europe, they're grown their market share very quickly, double-digit rates. From her personal experience back in the U.K., they forced major chains like Tesco to really bring down their prices and changed the competitive landscape there. So when it comes down to it, you have the giants out there like Wal-Mart and Kroger, but these guys can really induce some of those price savings for consumers overall, and change the expectations of what our grocery stores look like.

Kline: And I think it's going to force consolidation. Through the past couple decades, you've already seen not the total demise, but largely, the very small regional chains have gone away, or the single mom and pop grocery stores, a lot of those are gone. So some of these regional chains are going to have to combine to have the buying power. And you'll probably see some traditional grocery stores not be able to make the transition. You now have, in addition to Aldi and Lidl, you have Wal-Mart, Costco, Amazon, prices are being forced down. And unless you're Whole Foods, which has built up a premium audience, and they are having their struggles as well, it's going to be very hard to compete if you can't buy these items at the same prices as these much bigger companies.

Shen: Yeah. My last point here, it's a little bit on competition, going back to Wal-Mart. Their grocery business makes up over half of their revenue. I was reading about a test that they started earlier this year in over 1,000 stores, where they're doing a lot of pricing comparison to beat out places like Aldi and Kroger, in anticipation of this increasing competition, the more stores moving into the U.S. that they'll have to face off with. The hope is that they can lower their prices enough that Wal-Mart thinks they've won over customers pretty definitively, and then they can adjust their pricing as necessary. There were some leaks that Wal-Mart is going to some of their big suppliers, especially for some of the packaged goods -- think companies like Unilever and Procter & Gamble -- and basically telling them, "We need the prices that you charge us to be 15% lower," the idea being that Wal-Mart wants to reclaim the title of low-cost leader --

Kline: And that's a general big box practice. I've done some selling to big boxes, and if you get a SKU in, they will come back to you every year, every 18 months, and say, "How can you make it 3% cheaper?" And in some cases, they will even help you build a new factory, or do whatever it is you have to do, or, you could say, "Yeah, if you placed an order that was twice as big, here's what the price could be." So, they're going to work every angle. I think it's also worth noting that I had a story earlier this week that, at Sam's Club, the Wal-Mart version of Costco, their warehouse club, they consolidated their in-house brand from a whole bunch of different labels under one name. And I think that's something we're going to see more of, where Wal-Mart uses its Member's Mark brand and really tries to compete with these people. That's going to put some pressure on some of these name brands, to either lower prices or find new ways to compete.