October 22-23, 2015 Arlington, VA

October 22-23, 2015 Arlington, VA

Responding to the rise of the discounters: As Aldi expands and Lidl enters, how and when should incumbent American grocers react? October 22, 2015

Our Guest Speakers Need Chris Photo George Faigen Partner, North American Retail & CPG Practice at Oliver Wyman Chris Baker Partner, North American Retail & CPG Practice at Oliver Wyman Roland Neuwald Former CEO of Real, Germany, Member of Metro Group Private Brands Summit 3

Agenda Item Introduction Discounters and their relevance to North America Speaker Mark Baum George Faigen George Faigen Discounters successes in other geographies. How did they do it? George Faigen Live Interview: Lessons from a Pro What does this mean for you and your company? George Faigen Roland Neuwald George Faigen Question & answer session George Faigen Private Brands Summit 4

Discounters have entered and won in mature markets across the world Aldi and Lidl have plans to make a big push in the US Private Brands Summit 5

Both of these companies have had massive success in other geographies Company Facts Europe s largest grocery chain 3x the size of Walmart in private label; already 16 th largest food retailer in US and Canada 11,500+ stores 26 countries; EU only $87BN revenue (No. 1 in EU) EBIT margin > 3% ~1,600 SKUs including leading brands Average 9,800 sq. ft. stores Highly flexible 10,500+ stores 17 countries; EU, AUS, US $75BN revenue (No. 4 in EU) EBIT margin > 4% ~1,500 SKUs (still) focused on private label Average 9,800 sq. ft. stores Highly flexible Private Brands Summit 6

and the magnitude of their ambitions for the US appears substantial indeed Plans in the United States 100 US stores opening in 2017/18 HQ established in Arlington, VA Store sites being purchased $3 BN investment planned in the US Adding 530 stores prior to 2019 Expanding to CA by mid-2016 Private Brands Summit 7

But they start from a low base in a nation not used to this style of grocer retailing is there really any cause for concern? US Market by Channel $1,500 BN Warehouse clubs Liquor stores Drug stores Convenience stores Discounters 4% Mass merchant Supermarkets / grocery Note: All data for 2014 Private Brands Summit 8

The German discount model is simple but powerful Lowest possible prices Matching discounters on price is not an option. Aldi s extraordinarily lean operating model allows them to run approximately 7% EBITDA despite up to 12% gross margin disadvantage Very high level of store efficiency Discounters use store-specific mixed cases and pack sizes with display ready packaging, including bar codes on all four corners to enable quick scanning; they have very high turnover, and deliver a unexpectedly high level of service with a minimum number of staff Excellent product quality and value Low cost, but high quality private label products, including fresh products Bulls Eye lines Hard discounters use a single or very small number of products designed to pull in volume from the entire category. They design private label products that deliver equal to or better quality to national brands, sold at prices 30 to 60% less. Sophisticated talent management Top school hiring, paying highest salaries in the industry Private Brands Summit 9

The range will start with shockingly inexpensive products, but evolve and soon be very credibly adapted to the local market Sweden UK Private Brands Summit 10

They will look to take over baskets one step at a time At it s core is a targeted basket erosion strategy Bridgehead categories Focused on KVIs Ultimately, taking over the entire basket Private Brands Summit 11

and go aggressively after the Fresh categories Lidl will move aggressively into branded promotions on key SKUs Private Brands Summit 12

Both will seek to drive footfall using so-called in-outs great value promotions on non-food products outside the core range Private Brands Summit 13

Weak Offer Strong Their aim will be to establish unbeatable credibility on value while continually moving up the food chain on offer Customer perception mapping + Mass channel Discounters quickly improve their offer - Traditional grocery / supermarkets Discounters - Weak Strong + Value Private Brands Summit 14

In Germany, this strategy has moved them from irrelevance to dominance German grocery market shares 100% 90% Discounters 80% 70% 60% Neighborhood grocery 50% 40% 30% Supermarkets 20% 10% Mass merchants 0% 197 0 198 0 199 0 200 0 201 0 201 4 Source: EHI, GfK; Note: Excludes specialty stores Private Brands Summit 15

Market share Number of stores It took 20 years, but it is now happening in the UK - explosive ID sales growth and expansion at a breathtaking pace Aldi market share, number of stores UK (1990 2012) Number of stores Market share Market share growth: new stores Market share growth: like-for-like 3.5% Recession : 1990 Q3 to 1991 Q3 Financial crisis recessions 500 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 450 400 350 300 250 200 150 100 50 0.0% 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 0 Source: Planet Retail, Kantar, ONS Private Brands Summit 16

If you leave an open flank, it may take time, but discounters will exploit it and they are very willing to play the long game Germany UK United States Are the discounters present? Were/are consumers looking for value? Were/are the discounters poised for growth? What market share have the discounters achieved? 40% 20% * 4%+ *: UK market share estimate includes Asda Private Brands Summit 17

The early format in the US is easy to look down upon but it will improve as they expand Early format (US) Polished format (Germany / UK / Australia) Standard, uninspiring assortment Very basic store interiors Limited fresh selection Non-mainstream practices (e.g. no credit card acceptance, pay-for-use shopping carts) Excellent customer service Localized often exciting assortments Expanded non-food assortment to clothing and other goods, similar to mass merchants In-store practices are mainstream in the markets UK Supermarket of the Year 2012 & 2013 Lowest prices, lowered every year Lowest prices Private Brands Summit 18

Incumbent complacency is the discounter s best friend Mindset Reality The discounters are serving a different market segment We sell national brands, and they don t! We are just as cheap. Consumers just don t get it! Our promotional program can match the discounters value. We get paid handsomely to run promotions. So it s a win-win! The demographics of the customer sets are nearly identical Discounters offer brand names too, and their private label product is often preferred Discounters can offer cheap prices, without compromising on quality EDLP has a stronger value perception than promotions Source: EHI; Note: Excludes specialty stores Private Brands Summit 19

Live Interview with George Faigen and Roland Neuwald Private Brands Summit 20

What might this mean to you? 1 Understand the threat Discounters will grow their presence in the U.S. and steal market share from incumbent players. You need to understand where you are on the customer perception map vs. discounters 2 3 4 5 Resist before discounters become a serious threat Do not wait until the discounters have become a strong presence in your territory Drive out costs relentlessly Aldi is going to be here for the long term. You ll have to lower your cost basis or else you ll struggle to invest in price Focus on the right assortment How strong a connection do you have between what you offer and what customers expect, including private label Improve and leverage fresh departments You can continue to differentiate on the fresh offer, but it s no guarantee. Just having a produce department isn t good enough Private Brands Summit 21

Discounter growth and market penetration follows a broadly predictable pattern even though the timing varies by country Progression of discounters Opening in your market Discounter improves assortment, signs of localization Improved Fresh proposition at the discounter No discounter presence / immediate threat Announcement of broad market entry Discounter buys real estate / hires team Declining sales in your most price sensitive shoppers Where do you fall on the timeline? Declining sales in your KVIs Declining trips from your customers Private Brands Summit 22

Weak Offer Strong An effective discounter strategy involves improving not only on price but also on offer Customer perception map + Mass channel YOU - Traditional grocery / supermarkets Discounters - Weak Strong + Value Private Brands Summit 23

What if mulligans were possible in countries where discounters took off? Full-range traditional grocers would take the discounters very seriously early on spend a lot more time understanding what really is happening underneath the surface realistically assess their competitive positioning relative to the discounters prioritize sales and cash profit growth over percentage-margins invest in shelf prices instead of raising them whenever they can use promotions as an element of their strategy, not its absolute core communicate value and price competitiveness seriously upgrade the range offering, service, friendliness, shopability, check out times introduce value brands immediately and narrowed the price gap to brands introduce store brands, lifestyle brands, organics, kids brands all with good value for money Private Brands Summit 24

What does this mean for private label manufacturers? A number of possible upsides. and a few risks or downsides Opportunity to become a contractor for Aldi and Lidl Opportunity to invest in capacity, innovation, new product lines Traditional approach to private label could become more esoteric Risk of losing power by adopting Aldi or Lidl approach Aldi and Lidl could drive an increased interest in private label and, over time, create greater demand for private label vs. national brands With so much potential upside, what do you do next? Private Brands Summit 25

Questions from the group Private Brands Summit 26