The massive growth in the discount retail sector poses a problem for many retailers - how to compete in the so-called "age of the discounter". Driven by weak consumer spending power, the expansion of German discounters Aldi and Lidl seems unstoppable. But is this phenomenon limited to Europe? And is it set to continue? Kate Barker finds out.

The runaway success of discount retailers in Europe has caught many in the industry by surprise. Although many industry pundits confidently predicted that the discounters' share of the grocery market could not grow any further, it has defied forecasts and kept on growing. At the forefront of the hard discount sector are German retailers Aldi and Lidl, which are by far the largest players in the market. But the discount phenomenon is not limited to Germany, or even to Europe; it has also taken off in Japan and the US, as delegates at this year's IGD Global Retailing Conference found out.

Germany is arguably the birthplace of the hard discounter. Aldi and Lidl stock a limited product range of less than 1,000 lines, with an emphasis on own-label goods and local and exclusive brands. They stock limited national brands and their core focus is price. Their runaway success stems from their ability to provide customers with the lowest-price groceries when consumer spending power is low. As Anna Albrecht, mother of Aldi owners Karl and Theo Albrecht, once said: "The worse off people are, the better off we are."

According to Joanne Denney-Finch, chief executive of industry think tank IGD, this is the age of the discounter. Since the early 1990s the number of discount stores across Europe has doubled to around 30,000. Lidl is leading this growth, having increased its number of outlets to around 5,000 from fewer than 1,000 in 1991. In the US meanwhile, Dollar General has opened more than 5,000 stores in the last ten years and has more stores in the US than Wal-Mart has worldwide.

Smart shopping ethos spreads across Europe

"This is obviously a worrying trend for other retailers," Denney-Finch pointed out, especially as the hard discounters are also posting strong like-for-like sales growth. Aldi's sales have increased by more than 25% during the last five years, boosted by an increase in consumer price awareness amid poor economic conditions in continental Europe.

In Germany, Aldi and Lidl's success is helped by the fact that there is no stigma attached to shopping in their stores. It is considered intelligent in German society to buy groceries for the lowest possible prices. A person may drive a BMW and wear designer suits, but will still buy most of their groceries in a discount store. And this ethos is gradually filtering into the rest of continental Europe. In France, international retailers Carrefour and Casino have seen their discount formats post much stronger sales growth than their supermarkets and hypermarkets.

Revenue from Carrefour's French operations slid 1.1% to €9.30bn (US$11.3bn) in the first quarter, which Carrefour attributed to increased competition from discount retailers, as well as cut-price sales promotions. Although sales at its French hard discount outlets only amounted to €557m in the first quarter compared to €4.80bn at its hypermarkets and €1.94bn at its supermarkets, like-for-like growth at its hard discount operations was a strong 5.0%, compared to a 4.0% decline in hypermarket like-for-like sales and a 0.7% decline in supermarket sales.

Competing with the discounters

However, Carrefour has come up with a strategy aimed at competing with the hard discounters, even in its hypermarkets and supermarkets. The company developed Number One, a range of basic products sold at prices that it says are typically 6-7% cheaper than at hard discount stores. The Number One brand is company wide, and can even be seen at Carrefour's Polish and Latin American operations, and also multi-format, available in hypermarkets and supermarkets as well as its discount outlets. Carrefour has also launched a new own-label range called Produits Carrefour International, with 200 products currently on offer and a further 200 planned by the end of 2004. The company says the multi-format range is common across its French, Belgium, Italian and Spanish operations and is 15-20% cheaper than its traditional own label products. Developing these common ranges such as Number One and Produits Carrefour International has reduced the company's buying costs, enabling them to sell the products at much cheaper prices.

Carrefour has also introduced a price-driven loyalty programme in France, whereby customers can choose 25 products on which they receive a permanent discount of 10%. The discount savings accumulate on a loyalty card and can be exchanged for vouchers that can be redeemed in Carrefour stores.

For manufacturers of branded products the discount phenomenon poses a problem. Hard discount retail is traditionally geared away from national and international brands, focusing instead on own-label products. According to Andrew Garden, general manager of Procter & Gamble's Western Europe division, the company would consider working with anyone with a long-term commitment to buying its brands. When asked if it is difficult to negotiate a price with discount retailers, Garden admitted that it could pose a problem. After all, he said, you cannot offer a price to a discounter that is cheaper than you are offering other customers.

Steve Newiss, vice president global customers for Kraft Foods International, said it is important for manufacturers of branded foods to keep their integrity. Rather than offering lower-priced products, Newiss said Kraft would prefer to offer discounts to customers for genuine efficiencies in the supply chain.

Adapting for further growth

With talk of unstoppable expansion, one could be forgiven for thinking Aldi and Lidl are the be-all and end-all of grocery retailing, but of course, even they have their weak points. For a start, the very nature of hard discounting means a limited product range and unknown brands. Discounters invest little in marketing and the emphasis is always on price instead of customer service and shopping experience, meaning many discounters have a poor quality image.

However, things are beginning to change and faced with increased competition discounters are addressing their weaknesses. Where a product range consisting mostly of long-life products such as canned and dry goods was once enough, many discount retailers are now adapting and expanding their product ranges. Many are now offering fresh fruit and vegetables, fresh meat, ready meals and healthy eating alternatives, and even making over their stores to look more appealing. Own-label products are being improved, there is a greater emphasis on marketing and some stores are now accepting debit cards. Aldi and Lidl are trying to broaden their appeal while still keeping a strict focus on price. They are trying to capture the full weekly shop, rather than just those customers who are prepared to do part of their shopping at a discount outlet and the remainder elsewhere.

Focus is key to success

Discount retailers must not, however, get carried away with making changes. Of course, part of Aldi and Lidl's success is their range adaptation, but their strict focus on low prices has been key to their growth. According to Denney-Finch, in the long run it is only the really focused discounters, who follow a strict and simple operating model, that continue to achieve strong growth. In the US, it is the limited-range hard discount stores such as Aldi and Save-A-Lot, along with dollar stores such as Dollar General, that are achieving the strongest growth, while Price Impact formats, such as those developed by supermarket retailers Kroger, Albertsons and Safeway to help them capture price-sensitive consumers, are not growing at the same pace. Their larger product range makes them less cost efficient than hard discounters.

Looking ahead, demographic changes and the pensions time bomb suggest the number of price-focused consumers will increase further in the future, which bodes well for the discount retailer.

"In the US, we're also seeing a growing acceptance of 'smart shopping', or shopping around for value - a shopper psychology instilled by Wal-Mart. And that's helping the Dollar Stores attract customers from all demographics, with their share actually growing fastest in the highest income groups," said Denney-Finch.

This indisputable growth in the discount retail market means other retailers are left with a choice. They can either reduce prices and try to drive volumes and compete directly with discount retailers, or they can invest in service and quality, providing an alternative to the discount retail outlets. Whichever they chose to do, the clear message from IGD is to learn from the success of Aldi and Lidl by keeping it simple and staying focused.