Currently, discussions about China's hard discount retail format are increasing, with many media outlets publishing related articles and various themed conferences being held, including the second China FMCG Hard Discount Conference hosted by New Distribution. However, overseas, hard discount is already a very mature and clear retail format, and to this day, its share and growth rate continue to accelerate.
From March 14 to 16, the 9th China FMCG Innovation Conference, the 2nd China FMCG Hard Discount Conference, and the 2nd China FMCG Distributor Conference concluded successfully in Chengdu!
At the 2nd China FMCG Hard Discount Conference, over twenty guests discussed the development of China's hard discount industry from 2023 to 2024. Among them, Mr. Qi Te, partner at Zhengxuan Capital, delivered a significant presentation titled "Evolution of China's Hard Discount Business Model: A Sino-Foreign Comparison", which sparked lively discussions among attendees.
New Distribution is reporting the essence of his speech for our readers.
Qi Te primarily works in investment, focusing on the retail chain sector related to food and beverages. He has published several articles on the hard discount format in this public account and previously focused on overseas brands and retail during his overseas investment work.
First, let's break down the discount retail format. In English, it's called "discounter," which translates directly to "discounter" in Chinese. It is divided into two branches: hard discount and soft discount, also known as brand discount, because the proportion of private label products is lower compared to hard discount.
The boundaries between these two discount formats are constantly merging. Qi Te stated that from his perspective, the most fundamental difference in their business philosophy is: hard discount has a very streamlined SKU, using 1,000 SKUs to meet 70% of community consumers' daily shopping needs; while soft discount extends this further, using 3,000-4,000 SKUs to meet 80% of community consumers' daily shopping needs.
Learning from History The Process of Western Hard Discount Models
The above chart shows the ranking of the top 20 global retail enterprises. From the ranking, it is clear that among the top 5, there are 2 discount enterprises: Aldi and Schwarz. The two companies marked in red below are Rewe and Edeka, two comprehensive retail companies in Germany, which also have their own discount sub-brands, and currently, hard discount sales account for more than 30% of the parent company's total. The fourth column on the vertical axis shows the growth rate of all large retail companies in the past, and it can be found that discount format companies have the fastest growth rate.
Among all discount formats, hard discount is the most prominent. The above chart shows the ranking of the top 10 global discount companies, of which 7 are hard discount and 3 are brand discount (soft discount).
This is also the reason why hard discount, despite its high share in the West, still exerts great power and maintains extremely high growth rates and penetration rates.
The above chart positions all traditional retail formats based on two dimensions: price and added value. Traditional retail has occupied all shares, with little gap in between, and many consumers shop across multiple formats, such as visiting a membership store once a month, a traditional supermarket weekly, and a convenience store daily.
Among them, premium supermarkets, the most typical being Hema, OLE, and the recently popular Wegmans in the US, as well as Whole Foods Market. We find that some consumers are always willing to pay higher prices for a premium shopping experience.
So, the strategy of this type of premium supermarket is also called people-oriented retail strategy, including the brand discount strategy shown in the chart. The brand discount strategy has a higher SKU count than hard discount, around 3,000 to 4,000 SKUs, and the proportion of branded products is higher.
From the above chart, it can be seen that there is not much room left for new retail formats in the market. So how does hard discount carve out a niche in such a relatively red ocean discount market and create its value space?
The reason is that hard discount does not compete within traditional retail channels but shifts the price dimension further to the left, reaching a price level that traditional retailers cannot achieve.
At this point, the value proposition of hard discount becomes very clear. Once your product selection is drastically reduced and the added value of the retail format is greatly lowered, you will find that consumers become very utilitarian. They come to your store for low prices. If your products can provide them with a great value experience, they will make repeat purchases. This is how hard discount opens up a blue ocean market.
Of course, within this blue ocean market, strategies are also layered. First, Trader Joe's is the highest-end hard discount format globally, followed by LIDL and ALDI, including DIA, which is a very large hard discount format in Spain and Latin America. It adopts a convenience community discount approach with relatively higher prices. There are also Poland's Biedronka and Turkey's BIM, which are hard discount models that have been validated in developing countries, representing typical poor people's supermarkets, with the lowest added value and prices.
Regarding the characteristics of Western hard discount, let me mention a few key points.
First, minimalist SKU. Traditional consumer psychology says consumers can recognize up to 7 brands, but due to severe information overload and category fragmentation, we find that many consumers can only identify two or three brands in a category. Many consumers, when facing shelves offline and finding more than a dozen products in the same category, do not feel pleasure but annoyance. If retailers can help consumers simplify from the perspective of product selection, it can essentially be a win-win situation.
Second, deep discount. Discount is not just low price; it must ensure quality while achieving low prices. This is also a characteristic seen in all Western stores. All large hard discount stores eventually implement a private label strategy. The core reason at the bottom is that only when retailers implement a private label strategy can they simultaneously achieve low-price and quality strategies.
Third, high profit margin. Traditional European retailers have an average gross margin of about 27%, but the average net profit margin of stores is only 3 points. Hard discount has a gross margin of only 18%, but the net profit margin of stores can reach 5%. Hard discount stores are actually more profitable than traditional retail stores. Why? The core is compressing all intermediate costs, from labor to rent to depreciation. We find that each cost component is about half that of traditional retailers.
Fourth, fast expansion speed. In the West, the payback period for a traditional retail supermarket is about 5 to 7 years, but hard discount stores only need 2 to 3 years to recoup investment. Also, note that in the West, hard discount stores have higher efficiency in using working capital because of faster turnover. Inventory is about one week more than traditional retailers, and the upstream cycle is the same as traditional retail.
In Western hard discount, upstream suppliers also provide credit terms. China may not be the same currently because the scale is not large enough. Once a certain scale is reached, upstream will also provide credit terms. In fact, we can already see some signs: many snack food chain stores, when reaching a certain scale, have started to demand credit terms from upstream.
Looking to the Future The Evolution of China's Hard Discount Industry
After discussing overseas, let's talk about China. First, we need to understand that the hard discount model is very powerful, but its power varies by country. In the Nordic market, hard discount has almost disrupted traditional retail, accounting for 50% of the market. In the UK and Australia, although entry was relatively late, the speed is very fast.
In some countries, hard discount may not be as aggressive, but it still occupies a considerable market share.
Why does hard discount have different effects? Because hard discount requires a certain environment. What kind of social environment does it need?
First, the country's production capacity must be surplus. Only when a country has surplus production capacity will its retailers and brands become competitive.
Second, at least one generation of consumers in society must be completely affluent before they become mature. In category selection, they will begin to return to the basic attributes of products. In Maslow's hierarchy of needs, brands have many attributes: emotional, value, and basic. When consumers are mature enough, they will disenchant brands and research product ingredient lists, taste, and healthiness themselves, especially among the middle class.
Third, the economy needs to experience several downward cycles. This is the cycle China is currently experiencing and has been validated in overseas markets. When consumers truly experience anxiety about wealth, they may truly recognize the value of discount stores. So every time the West experiences a financial crisis or economic recession, it is a period of accelerated growth for discount stores.
Fourth, whether there is room for excess returns in the retail industry, or relatively low competition. The global retail industry's EBITDA margin is about 5%, and net margin is 3%. We generally believe that if it exceeds 5% EBITDA margin or 3% net margin, the country's retail industry has excess space and is relatively less competitive. If it is lower, the retail industry is relatively more competitive.
Here's a story: why has hard discount grown so fast in the UK and Australia? A core factor is that before Aldi entered Australia, the local retail industry's EBITDA margin could reach double digits. Local retailers were thriving, pricing well above actual costs, and consumers accepted it. Imagine once a discounter enters such a market, it will sweep through like a storm.
Fifth, dietary diversity. As mentioned earlier, the core philosophy of hard discount is to meet 70% of community consumers' shopping needs with streamlined SKUs. If you open a supermarket in China today, operating a fresh food section requires at least 200 SKUs, which accounts for 20%. In contrast, Turkey's BIM is the fastest-growing hard discount format globally, opening 10,000 stores in just 20 years, surpassing ALDI, due to its geographical location. In Turkey's local markets, it's hard to find more than 5 types of fresh produce, and dietary habits are very simple. When BIM added onions, potatoes, and peppers to its shelves, that was their so-called fresh food section, but it didn't affect consumers' perception of it as a supermarket. But in China, you can think about what would happen.
So, what problems does hard discount currently face in China?
First, China's retail industry is indeed very competitive, with what we internally call borderless competition between online and offline. This is completely different from overseas. Overseas, you can simply open a store without considering online issues. But in China, if you rely solely on community revenue, the source is very single, and using such low gross margins for online might not be profitable.
Second, doing fresh food is death; not doing fresh food, many stores clearly have insufficient revenue.
Third, the ramp-up period is long, and the payback period is long. It seems that such stores can only be operated directly. If franchising is opened, many store models, in today's Chinese franchise chain market, are not very attractive to Chinese franchisees.
Fourth, blindly intervening in private label products at an early stage of the enterprise. There are many stories here, some to tell capital stories, some to increase gross margins, but I won't elaborate. I want to express that doing private label in China today is a completely different market environment from doing private label overseas.
Therefore, the complexity of China's retail industry far exceeds that of any Western society. This also requires practitioners and founders to have bold and unconventional attempts.
For future evolution directions, let me briefly outline the framework: assortment, location, pricing, promotion, quality, and service. The first four are the traditional retail 4Ps, and the latter two, quality and service, are more about thinking from the perspective of consumer value enhancement.
First, assortment: for example, whether to do fresh food. If not, how to attract offline consumers to the store? This is essentially different from snacks because snacks naturally have offline and impulse consumption attributes. How to assemble products to remain attractive compared to online is very important.
Second, location: some very smart models choose to open stores in shopping malls, effectively avoiding the need to do fresh food because the customer base is different, and they can profit from beauty products. Based on this, can we use elimination to find other locations besides communities and supermarkets?
Third, pricing: assuming all hard discount retailers use EDLP pricing, can I be more flexible and combine high-margin products in certain categories? This is an exploratory method.
Fourth, promotion: Western traditional hard discount logic is to do no promotions, but today in China, not doing promotions is absolutely not allowed. The problem Chinese hard discount solves is store revenue, incremental growth, not cost-cutting. Moreover, there are many tools available in China, such as supply chain systems and private domain traffic.
Fifth, quality: currently, hard discount is a bit like early community group buying, with everyone competing on low prices. But we believe that in the future, a group of retailers will emerge that differentiate by enhancing value.
Finally, service: does hard discount necessarily equal poor people's supermarket? Absolutely not. Today, Costco is ranked in the top two for consumer satisfaction in the US, and its growth rate and efficiency are far higher than LIDL and ALDI. The core reason is that it adds service on top of hard discount. So how to enhance service is also worth thinking about.
Finally, three sentences for our readers.
First, discounting is a historic process; you must resolutely bet on it.
Second, China's discount retail business will definitely not be dominated by one model. Persisting on the path that keeps you alive is the right path.
Third, don't be afraid. No one in China has the right answer in the discount industry, but the right answer may appear among those with "unconventional" and "rebellious" thinking.
PS: For those interested in the on-site speech content, please follow the recent posts on the New Distribution WeChat official account. We will compile and publish all guests' speeches for our readers.
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