LONDONJanet Wadsworth abandoned U.K.

grocery giant Tesco PLC for discounter Aldi after the German chain
opened a store near her home in the English village of St. Bees three years ago.
It used to be that people might have been embarrassed to be seen at Aldi, says the 51-year-old teacher. But I think
thats gone.
Ms. Wadsworth is part of a new wave of British shoppers chasing bargains with little regard to where they find
them. The shiftdriven here in large part by two, newly aggressive German discounters, Aldi and its archrival Lidl
has shaken the U.K.s $274 billion grocery industry to its core.
The traditional U.K. grocer had huge margins, says David Herro, a fund manager at Chicago-based investment
firm Harris Associates, which, until recently, was a large Tesco shareholder. In the current environment, Its like
exposing your neck to the discounters, like to a vampire, he says.
Indeed, as the discount-driven German duo expanded offerings, they have stolen away market share from the
countrys traditional players. Those grocers, in turn, have seen their stock prices plummet, triggering executive
ousters, layoffs and billion-dollar write downs.
Such turmoil here is reminiscent of some of the same industry headwinds hitting grocers elsewhereparticularly in
the U.S. With discounters on one end, and upscale grocery chains on the other, opposing forces are pressuring
profits. The result has been forced consolidation, and, in some cases, more desperate measures.
On Monday, Tesco, the U.K.s largest retailer, said it had agreed to sell its South Korea business for $6.1 billion in
casha retrenchment that comes after the grocer has also quit Japan and the U.S. and been forced to strike a joint
venture for its Chinese operations as it works to stem the slide in market share back home.
Our business has not been as competitive in recent years as we would like it to be, acknowledged Tesco Chief
Executive Dave Lewis on an April conference call.
Andy Clarke, CEO of Wal-Mart Stores Inc.s Asda, Britains second-largest grocery chain, has been more blunt,
calling the goings-on the worst storm in retail history.

Storm spreads to U.S.

Similar challenges are washing up on U.S. shores. A&P, Americas first traditional supermarket chain, with roots
dating back to 1859, said in July that it would close or sell its remaining stores as part of its bankruptcy filing. The
moves come after years of it being squeezed by an array of new competitors, such as Whole Foods Stores Inc. on the
high-end to cheaper alternatives like Wal-Mart and Aldi.
Seeking scale in the U.S. and Europe, Dutch grocery giant Royal Ahold NV and Belgian rival Delhaize Group
agreed in June to merge in a deal that will create a $29 billion titancombining American chains like Food Lion
and Stop & Shop.

ENLARGE

The $1 trillion U.S. grocery market remains largely regional and fragmented, despite a wave of consolidation in
recent years. That insulates it somewhat from the sort of carnage ravaging the U.K. market. Here, the countrys four
biggest grocers are national chains that butt heads everywhere, and on everything from online deliveries to supplier
relationships.
But now, the two scrappy German discounters that have wreaked the most havoc in Britain are ratcheting up their
U.S. ambitions.
In June, Aldis U.S. operation said it would pour about $3 billion into opening new stores, including across the large
southern California market. It plans to operate 2,000 stores by the end of 2018, up from the 1,400 it runs now across
32 states. Kroger, by comparison, operates about 2,600 stores in 34 states.
A day after Aldis U.S. announcement, Lidlowned by Germanys Schwarz Group, Europes largest retailerfired
back, outlining its own plans to enter the market, likely by 2018.
Analysts and others say the moves threaten to pressure discount chains like Wal-Mart and Supervalu Inc.s Save-ALot, but could also further shake up the wider U.S. market.
Theyre on everybodys radar in the U.S. today, says Craig Rosenblum, partner at retail consultancy Willard
Bishop, of Aldi and Lidl, adding: Everybody knows how successful they are in Europe.

Long looked down upon in class-conscious Britain, no-frills Aldi and Lidl gained traction only after the recession
here. At the time, the countrys biggest grocers kept jacking up prices, even as unemployment jumped and customers
tightened their purse strings.
At a time of slow to declining volumes, they attempted to raise prices and widen margins, says Andy
Higginson, chairman of No. 4 British chain Morrison and a former board member at market leader Tesco.
Customers recognized this and voted with their feet.
Aldi and Lidl acted swiftly, ramping up advertising and expanding their product lines to include more fresh produce
and baked goods. The two chains together now command 9.7% of the British market as of August 16, according to
Kantar, up from 5.9% three years prior. Even their competitors acknowledge the creeping threat.
I believe the discounters will get to 15% of the U.K. grocery market by 2022, said Sainsbury CEO Mike Coupe at
a meeting with journalists in May. Aldi and Lidl, he said, are formidable competitors.
The chains have kept prices low by prioritizing speedy store deliveries, efficiency and high turnover at the expense
of breadth of offerings and customer service. As part of that push, Aldi and Lidl take daily deliveries of a slim range
of mainly private-label products, often with the look and feel of popular, branded items.
By not offering this huge variety weve made the offering and our range efficient. says Lidls marketing director,
Arnd Pickhardt. We provide just a handful of different mineral waters, about seven, compared with other
supermarkets that have a whole aisle full of space for waters, he says. The stores smaller footprint also saves on
costs.
Some products are sold directly off the delivery pallets, while others arrive in boxes with open fronts, allowing the
staff to quickly move them in bulk onto store shelves without being unpacked from the boxes. Lidl drives its trucks
through the night to avoid traffic and save fuel.
Both grocers charge for bags, which customers take to packing areas that help keep the register areas moving. Aldi
and Lidl cashiers also do double duty, stocking shelves when things are slow.

ENLARGE

Price-sensitive shoppers have dispensed with any qualms about shopping at discounters like Aldi, which offer fewer brands at
competitive prices. PHOTO: JASON ALDEN/BLOOMBERG NEWS

We can operate at a far lower margin because of our efficiency, says David Hills, Aldis U.K. group buying
director. Everyone in our shops needs to do every job from mopping to check outs.

Shoppers have been willing to go with the program in return for better prices. Nick James, a 27-year-old urban
planner in London, used to frequent Sainsburys until he wandered into a Lidl to buy a croissant about 18 months
ago.
Lidl has funny European brands, he allows, and the stores arent quite as plush or neatly presented as those at
Tesco or Sainsbury, which competes with Asda for the markets No. 2 position.
He says he also finds it really frustrating when he cant find anyone at the cash registers to check out. Still, he has
switched to shopping almost entirely at Lidl because the quality is just the same, but the prices are more
affordable.

U.K. grocers adjust

The Germans success is proving calamitous for Britains traditional grocers. In the past year, shares of Tesco,
Sainsbury and Morrison have fallen more than 13% on average, amid profit warnings, billions in property writedowns, and canceled or slashed dividends. They have axed jobs and closed or shelved plans to open stores. Two of
the three have recently ousted their chief executives.
Yet the results have been a boon for consumers. A loaf of whole wheat bread here now costs an average of 98 pence
($1.50), down 15% from a year ago, according to the Office of National Statistics. Shopping has also never been so
convenient, with the big grocers expanding their click-and-collect servicesallowing customers to order online and
pick up from stores, gas stations or other locations.
Morrison has cut prices on 1,665 products by an average of 16% since the start of last year. Wal-Marts Asda,
meanwhile, earlier this year plowed nearly 300 million ($458 million) into reducing the prices of 2,500 basic items;
Sainsbury dedicated 150 million to fund lower prices.

ENLARGE

Tesco had weathered the recession of the early 1990s better than rivals by introducing lines with bare-bones
packaging that appealed to cash-strapped shoppers. It rolled out a pioneering loyalty cardnow copied the world
overthat tracked shoppers habits. Memorable TV ads featured a dedicated but hapless Tesco buyer, played by
Dudley Moore.
In that period, Tesco did a good job of understanding the changing environment and readjusting its overall
competitive offer, says Terry Leahy, who took over as chief executive in 1997. Over the next 14 years, he

transformed the chain into a global retail powerhouse, competing on the world stage with Wal-Mart and
Frances Carrefour SA.
Then the latest recession hit Britain in 2008 amid the global economic crisis. Unemployment jumped, leaving
increasingly panicky customers hunting for bargains. But grocers raised pricespassing along higher commodity
costs to defend margins. Grocery inflation peaked at 9.3% year-over-year in October 2008, according to Kantar.
They had such a strong grip on the market that obviously they felt they could do it, says Bruno Monteyne, a
Sanford C. Bernstein analyst who worked as a Tesco executive for 10 years. Margins at Tesco, Sainsbury and
Morrison rose steadily through the downturn, to an average of 8.1% in 2010, from 5.8% in 2005, according to
Bernstein.
Over the next few years, the economy started to perk up, but worried shoppers stayed frugal. Tescos Chief
Executive at the time, Philip Clarke, rolled out a 500 billion price-cutting campaign nicknamed the Big Price
Drop shortly after taking the helm from Mr. Leahy in 2011. Critics said the cuts didnt go far enough and dubbed it
the Big Price Flop.
Mr. Clarke couldnt be reached for comment. A spokesman for Tesco didnt respond to a request for comment.
Mr. Clarke also poured 1 billion into revitalizing sales: updating stores and brands, reining in store expansion and
cutting prices, among other moves. But after two consecutive years of falling profits, the board replaced him last
year with Unilever PLC veteran Mr. Lewisthe first outsider CEO in its history.
Mr. Leahy said Tescos strategic direction was the right one during his tenure as CEO. It was from 2011 onward
that strategies failed to gain traction and resulted in market share loss, he said.
An accounting brouhaha made matters worse. Shortly after Mr. Lewis started, Tesco disclosed it had overstated
profit in the first half of 2014 by 263 million.

ENLARGE

Discounts at Germany's Lidl has prompted at least one big U.K. grocer to match prices. PHOTO: SIMON DAWSON/BLOOMBERG NEWS

The U.K.s Serious Fraud Officewhich has the jurisdiction to criminally prosecute entire companies, as well as
individuals, on matters relating to fraud, corruption and briberyin October opened a criminal probe. Tesco at the
time said it was cooperating fully with the SFO and will continue to do so.

Around that time, Warren Buffett publicly characterized his underperforming investment in Tesco as a huge
mistake. Last year he unloaded most of what had been a 3.98% stake in the company.
Others decamped, too. Mr. Herro, of Harris Associates, says the firm had owned 3.2% of Tescos shares last summer
but has since sold virtually its entire stake.
This past April, the retailer reported its steepest annual loss on record, partly because of a 4.7-billion property
write-down. Tescos big stores are a noose around their necks, says Mr. Herro.
Mr. Lewis, meanwhile, isnt prepared to go so far. In April, the CEO pointed out to journalists that shoppers still
visited big stores. Maybe they arent the dinosaurs that people have painted them to be, he said.
Mr. Lewis has slashed prices by 25% on average across hundreds of branded products. He has also closed dozens of
stores and cut thousands of jobs at Tescos head office. He has beefed up the number of employees on the shop floor
and slimmed down Tescos product range to make space for the most popular items.
He continues to try to turn Tescos biggest stores around. For shoppers who want to linger, or even make a day of it,
an 84,000-square-foot store in the London suburb of Watford has a nail bar and a community room for activities like
yoga, an optician, and a restaurant, among other diversions. Tesco and its competitors have also been opening
smaller, urban shops at a brisk clip.
Aldi and Lidl, meanwhile, are pressing their advantage, adding fancier new fare. Ms. Wadsworth of St. Bees is a fan
of Aldis cheese, Prosecco and smoked salmon. They also do some fantastic fish cakes that are absolutely out of
this world, she says.