While retail consultants focus on technology are they forgetting the basics?

I've just finished reading Retail Disruptors, an extraordinarily insightful book on the impact of hard discounters with a focus on Lidl and Aldi. At 242 pages cover to cover, and packed with diagrams and tables, the book is a rich, detailed trove that explains in large measure why retailing - and grocery retail, in particular, is proving to be such a minefield.

The book's authors, both of whom are academics steeped in retail, provide a wealth of information I've not seen covered elsewhere and to which you can go back to time and again. The book is also highly accessible.

Why does this book excite me?

The book's position is one of examining the hard discounters and the competitive responses from a business model standpoint. Interestingly, while the authors mention Amazon, they barely touch on technology impacts, preferring instead to examine the management behaviors and responses to the disruptors. This is almost diametrically opposed to the responses outlined by consultants like PwC who, in their 2019 Retail Outlook (registration required) put the emphasis squarely on technology as 'the' response to current market conditions. Are they leading their customers down the proverbial garden path? Let's consider recent events.

The current turmoil

Commenting upon the recently announced deal between Ocado and M&S, Stuart Lauchlan thinks the deal has a lot going for it. Viewed through the lens of scaling out, then yes, it has. As a long term platform play to other retailers looking for online capability, again, yes from Ocado's perspective.

But then despite its premium positioning, M&S reported volume numbers off 2.7% for the UK in its January 2019 results. For its part, Ocado is adding customers and volume at a healthy clip - the latest reported figures show revenue up 12.1%. But hidden in the detail is the fact that per customer spending is falling. In the 13 weeks to 2nd December 2018, the average spend was £104.91, down 1% from Q4 2017 and well off the £108.18 reported in H1 2017.

Elsewhere, we saw that John Lewis got itself into all sorts of trouble, largely as a result of having to compete in a heavy discounting market. Curiously Waitrose did rather better and, from what I can see, is the only grocery led retailer outside the hard discounters that is performing well in the UK market. But even Waitrose is not immune from volume hits. In the latest update, Waitrose is running at basically flat growth.

All of which is a prelude to asking the question, should retailers be so focused on technology innovation or should they look more closely at business model innovation? M&S will almost certainly argue that its model is one based upon understanding its market position and betting that the more affluent shopper will be happy to be offered a full assortment via the Ocado tie up. But, as we have seen from past missteps by Morrison in its online adventures, nothing is guaranteed.

The retail disruptor

Retail Disruptors makes a powerful case for retailers having a much better understanding of how the hard disruptor business model works and then figuring out either defensive or aggressive tactics to counter the insurgency. The model as outlined is remarkably simple although I think that even Lidl and Aldo would agree that economic conditions have been in their favor. It goes like this:

1. High volume per SKU but with a limited assortment
2. Irresistible value for money
3. High profitability
4. Rapid store network expansion

The devil as always is in the detail but a few points stood out to me that put Aldo and Lidl in a unique position.

• The hard discounter has benefited from long term wage stagnation as consumers become more cost-conscious. Shopping at Aldi or Lidl does not carry the social stigma it once did.
• Reduced choice helps the time-pressed consumer make a quick decision.
• Achieving comparable or better quality to national brands with private label is a conscious decision.
• The hard discounters remove as much friction from procurement as possible in part by creating long term relationships with suppliers.
• Comparatively, little marketing spend and minimising overhead at every turn.
• As privately owned firms, Lidl and Aldi, in particular, are not subject to the relentless grind of public reporting so have economic freedom outside the public gaze.

The net result is that rather than competing with the mainstream retailers, whom they are quite content to see slug it out with one another, the hard discounters have carved out an area of  blue ocean in which they will happily compete against each other.

None of the above means the hard discounters are unbeatable or that they don't misfire. Only recently we saw sensational headlines about a canned SAP implementation at Lidl that allegedly meant writing off €500 million. Neither party is talking about that but I think the telling point comes in this commentary from Handelsblatt:

Apparently one of the biggest problems was a “but this is how we always do it” mentality at Lidl. Changing the software necessitated reassessing almost every process at the company, insiders say. But Lidl's management was not prepared to do that.

Unlike many of their competitors, Lidl bases its inventory management system on purchase prices. The standard SAP for Retail software uses retail prices. Lidl didn’t want to change, so the software had to be adapted. Many more accommodations had to be made, and the more changes there were to the code, the more complex and more susceptible to failure the Lidl software became.

[My emphasis added]

Why is this important? Lidl has a proven model that has seen it successfully saturate the German market, expand across 20 countries, all the while achieving a CAGR of 7.2% between 2012-17 that includes forcing the mainstream retailers into finding credible responses, often without success.

Whether Lidl has made an error in judgment remains to be seen but the book authors don't think it's wise to bet against them. And let's not forget that while €500 million is a huge chunk of change, it is less than 0.5% of Lidl's annual revenue. In short - a rounding error.

Do the consultants offer credible alternatives?

The PwC report notes that in its analysis, 41% of respondents in the groceries category expect to shop around more in the face of anticipated rising prices. More generally, PwC assert that:

In response , PwC is long on technology buzzword bingo but bucketed into three strategic segments. Check this graphic:

Pretty cool huh? The detail is more interesting:

Stock optimization is an interesting segment. According to the book authors, mainstream retailers carry some 45,000 SKUs compared to the 1,000 on offer at Aldi. How do you optimize for that? And given that omnichannel is not exactly a proven strategy, then why would you invest there? Dynamic pricing is an interesting idea and one that we see in ongoing price comparison and juggling among the mainstream retailers but it's far from clear whether that serves to improve profit from volume enhancement.

But where in all this is a strategy to beat out the category insurgents? Part of the offered answer comes in a muted view about M&A. Retail is littered with M&A failure and you might think for example that buying into the hard discounting market would be an answer. But as the book points out, this 'dual tracker' strategy has not proven successful. Why? Just as in every other market, (and we can take this one to the enterprise software vendors in spades!!) the problem is one of corporate DNA. Operating in the grocery blue ocean environment requires a different skill set to that of the traditional retailer and pretending that you can learn without a full-on change management project in place is a fool's errand.

What about cost cutting?

PwC recommends relentless efficiency but there have to be question marks around whether the traditional market can achieve enough to make them competitive.

The book authors detail the different cost structures of the hard disruptor and the traditional retailer. Here, there is a striking difference below the gross profit line such that the traditional retailer should have enough in overhead slack to help drop prices and still earn good margins. But that's hard when you've got established infrastructure needing ongoing maintenance or a need to continually support brands.

On the other hand, the hard discounters face a different problem. They're already cost optimized below the gross margin line, so can they squeeze more from COGS? The short answer is yes, when they can continue to make the increased volume argument but even there some care is needed.

McBride, a large UK detergent manufacturer to the hard discounters is journeying on a long-term recovery program. However, when it recently provided its half-year trading statement it noted that:

We continue to expect the overall raw material pricing outlook to show improvements in the second half, but not to the extent anticipated in early January.

In addition, distribution costs continue to rise beyond our previous estimates due to market rates and efficiency challenges driven by logistics capacity shortfalls and internal service gaps.

Accordingly, although the Group continues to anticipate further good sales growth in the second half year, the board now expects full-year adjusted profits before tax to be approximately 10% to 15% lower than the prior financial year.

The share price was dinged 27%. It is not in Aldi/Lidl's interests to squeeze these folk so what do they do? Continue expansion in the expectation that higher volume leads to lower COGS.

It's complicated

The retail market and especially the grocery led segment is a complex market. It would be nice to think that focusing on technology as a way to improve or sustain performance would result in better retail outcomes. But the hard truth is different. The technology buckets identified by PwC will surely gain headlines and Amazon's recent announcement to open a fresh tranche of stores will also send some shivers along the industry spine.

But even Amazon has discovered that entering a market with a view to using its logistics prowess to drive value isn't a slam dunk. Its whole Foods acquisition hasn't quite worked out the way some pundits thought.

In, Was Acquiring Whole Foods Amazon's 'Bridge Too Far'? Brittain Ladd makes the argument that:

1. Amazon plans in terms of a decade. The press may believe that Amazon will have an immediate impact on the grocery industry but I warned that it will be 2020/2021 at the earliest before Whole Foods will be in a position to take market share. It could even take longer.
2. Amazon should terminate John Mackey, Whole Foods CEO and founder, sooner rather than later. Mackey should remain CEO for no more than six months to one year. (I like and respect Mackey but transforming a company with a founder still in the role of CEO is challenging.)
3. Amazon will have to drastically modify the product assortment inside Whole Foods to increase customer traffic. Specifically, Amazon will have to introduce CPG-branded products (Coca Cola, Pepsi, Oreos, Tide) on shelves and online, introduce its own private label brands, and remove many of the products currently stocked and sold at Whole Foods; the items should be made available online only. (Read this article to gain a better understanding of Amazon's private label and CPG ambitions.)
4. Amazon must improve product pricing and value to increase customer traffic.
5. Amazon cannot maintain the status quo as doing so would mean certain failure. Whole Foods was faltering when acquired by Amazon.
6. If Amazon executes, the company can become the leader in grocery sales between 2030 to 2035.

Notice how he is touching on many of the points discussed?

My take

Retail grocery led business is at the bleeding edge of the interplay between consumers, store operators, online and manufascture. As such it provides a fascinating lens into how these B2B2C markets actually work.

Researching for this story reinforced a set of thoughts I've had for some time. Technology is certainly an enabler for change and innovation but on their own, technologies are only tools. They have to be seen in a much broader context that is balanced against credible strategies.

Viewed through the relatively narrow lens of retail disruptor v mainstream has been a good way to understand how the evolution of the market is affected by multiple factors. But even the book authors, who offer a wealth of possible competitive strategies are clear that while this market continues to evolve, the final winners have not really emerged. Technology will have a continuing and significant role to play but my guess is that if anything, technology will make it harder for retail decision makers to know where to place their bets. Why?

It seems to me that techonology provides the consumer the kinds of choices both in terms of brand and channel that have not existed in the past. It is, therefore, much more important for retailers to better understand their customers and play to their preferences. I suspect for instance that the days when consumers made a single supermarket choice are gone. The savvy shopper is here to stay. Tapping into what that means will be essential.