The Next Wal-Mart?

Secretive. Powerful. How far can Germany's Aldi go?

At first glance, an Aldi Group store in Germany seems like an unlikely staging area for world conquest. Jars of asparagus and cans of sardines poke out of cardboard boxes piled atop pallets. The line at the registers is 10 people deep, and the product range is reminiscent of East Berlin, circa 1975. Two brands of toilet paper. One brand of pickles. But the prices are delightfully, breathtakingly low. Three frozen pizzas for $3.24. A bottle of decent Cabernet: $2.36. How about a $21 trench coat?

Germany may be the land of the $100,000 Mercedes-Benz land yacht, but it's also a land of ebbing wealth, where less than a fifth of the population has discretionary income of more than $375 a month, where even haut bourgeois families will lay out for a fancy car but stint on the staples. Thus Aldi stores are found not only in working-class neighborhoods but also in wealthy communities like Bad Homburg, a Frankfurt suburb where the Aldi parking lot is thick with BMWs and Mercedes. A cookbook devoted to recipes using Aldi ingredients has sold 1 million copies, and there is even a connoisseur's guide to Aldi wines, which often sell for a few dollars a bottle. A recent survey by Nuremberg-based market researcher GfK found that Aldi is Germany's third-most-respected corporate brand, just behind electronics giant Siemens (SI ) and auto maker BMW -- and ahead of DaimlerChrysler (DCX ). An astonishing 89% of German households shopped at least once at Aldi last year, according to GfK. That has made reclusive co-founder Karl Albrecht the world's third-richest man, with a fortune estimated at $23 billion by Forbes magazine. Aldi -- short for "Albrecht Discount" -- "is a huge cult," says Matthias Kövér, a Cologne resident who maintains a Web site for devotees.

Lock on Budget Shoppers

Aldi is Europe's stealth Wal-Mart. Like the Arkansas-based giant, Aldi boasts awesome margins, huge market clout, and seemingly unstoppable growth -- including an estimated sales increase of 8% a year since 1998. It relentlessly focuses on efficiency, matching or even beating Wal-Mart Stores Inc. (WMT ) in its ability to strip out costs. Yet privately owned Aldi is also very old-school German, financing expansion with cash to avoid debt, shunning publicity, and moving quietly into new markets before the competition catches on. That has allowed the onetime local grocer in Essen to become one of the world's biggest retailers, with $37 billion in sales, a fraction of Wal-Mart's $245 billion but enough to give Aldi a 3.5% market share in Europe, vs. 6.8% for market leader Carrefour, according to Brussels-based market watcher M+M Planet Retail. Even mighty Wal-Mart has struggled against Aldi in Germany. Wal-Mart has other problems there, such as a lack of sites for its jumbo-size stores. But a big obstacle is that Aldi and other discounters already had a lock on budget food shoppers. "Aldi was doing the same thing as Wal-Mart before Wal-Mart got here," says Frank Pietersen, a retail analyst for KPMG in Cologne.

The discount chain already is having a Wal-Mart-type effect on the German economy. The main association of German retailers issued a report on Mar. 8 blaming Aldi and other "hard discounters" for running 35,000 small shops out of business last year. On the same day, Bavarian dairy farmers picketed Aldi stores, which they blame for a ruinous 15% plunge in milk prices since 2001. Aldi must take care not to let such criticism tarnish its reputation among German consumers.

What's next? Aldi now shows signs of stepping up the pace of its expansion on Wal-Mart's turf. Aldi opened its first U.S. store in Iowa in 1976 and has sales of $4.8 billion in North America, according to M+M. And Trader Joe's Co., a specialty grocer owned by a family trust that Aldi co-founder Theo Albrecht created for his sons, has become the hottest thing in U.S. retailing by extending the Aldi concept to upscale products like wine and cashew butter.

Aldi aims to open 40 stores a year until 2010, bringing the U.S. total to 1,000. Aldi is even buying up sites from retailers trampled by Wal-Mart. "It is an uncharacteristic weakness of Wal-Mart that it has not recognized how formidable a foe Aldi is," warns Burt P. Flickinger III of New York City-based Strategic Resource Group, a retailing and consumer goods consultant. He expects Aldi to have as much as 2% of the U.S. grocery market by the end of the decade, up from 0.65% now. Says Wal-Mart spokesman Bill Wertz: "We certainly recognize Aldi as being a tough competitor."

Will Aldi take over the world? It's clear it is on the march, advertising on the Web for workers and store locations in places such as Ireland and Australia. "One of the principles of Aldi is not to rush into things, but first to build a solid foundation. Once they have that, they move more quickly," says Dieter Brandes, a former Aldi executive who has published a book, The 11 Secrets of Aldi Success.

Aldi -- actually two associated retailing groups controlled by Karl Albrecht and brother Theo, both in their 80s -- is Europe's biggest "hard discounter," the term for a retailer that pushes prices even lower than traditional discounters. Hard discounters have doubled their share of the European grocery market in the past decade, to 9.5%, according to ACNielsen. "They're coming, and they're going to change the retailing landscape for good," says Volker Koch, Frankfurt-based analyst for M+M.

Aldi follows a simple but devastating strategy. A typical Aldi has only about 700 products, compared with more than 20,000 at a traditional grocer such as Royal Ahold's (AHO ) Albert Heijn and as many as 150,000 at a Wal-Mart Supercenter. Established brand names like Nestlé or Nivea or Persil are irrelevant at Aldi. Almost everything on display is an Aldi-exclusive label such as Frisco Dent toothpaste (61 cents for a family-size tube) or Rio D'Oro orange juice (74 cents a liter) in Europe. The Aldi lineup even seems to be winning over U.S. shoppers. "They're not the brands I'm used to, but they're good. Nestlé has nothing on this," says retired schoolteacher Silvia Randall, holding up a package of LaMissa hot cocoa mix at an Aldi in Smyrna, Ga.

Because it sells so few products, Aldi can exert strong control over quality and price. The limited selection simplifies shipping and handling. A survey by consultants McKinsey & Co. found shoppers perceived little difference in quality, assortment, or service at Aldi, vs. traditional retailers, but they rated Aldi better on price. "We have a lot of respect for Aldi quality," says Wolfgang Gutberlet, CEO of Fulda, Germany-based tegut, which operates about 300 food stores in western Germany.

Obsessed with Frugality

The fanatic attention to costs pays off. Aldi's operating margin in some regions of Germany is as high as 9.3%, according to McKinsey. "Aldi has taken the retail formula down to the most basic elements," says Neil Z. Stern, senior partner at Chicago retail consultant McMillan/Doolittle LLP, who believes Aldi is more efficient than Wal-Mart. One knowledgeable estimate puts pretax profits at $1.5 billion.

Aldi's formula is as much the result of necessity as brilliance. When Karl and Theo Albrecht returned from Allied POW camps after World War II, residents of bombed-out Essen wanted only the products they needed from one day to the next, for the best price. So the brothers restricted their assortment to a few hundred items and carefully monitored quality. "Our business was managed solely on the basis of the lowest price," Karl Albrecht said during a rare public appearance in 1975. The Albrechts have avoided the spotlight since 1971, when Theo was kidnapped for 17 days. He was released in return for a $4 million ransom -- after bargaining to get the price down, according to press reports.

Frugality remains an obsession. Theo Albrecht turned off lights when he entered a room if he thought daylight sufficed, according to Brandes. Theo still goes to work daily, while Karl has turned over day-to-day management to professionals. Brandes says little is likely to change when the Albrechts are gone: Ownership has been transferred to trusts to avoid disputes among heirs.

Will Aldi prove as successful a German export as BMWs? In Europe, retailers are certainly feeling the heat. The Netherlands' Albert Heijn cut prices on 2,000 products last year to try to thwart the hard discounters. ACNielsen even sells a risk assessment profile to help other retailers figure out when an Aldi product threatens sales. Foreign grocers have had lots of time to prepare for Aldi. In Britain, Aldi has just 1% of the grocery market 14 years after opening its first store. Tesco PLC has defended share with its own low-priced brands. Hard discounter Lidl, a unit of Neckarsulm-based Lidl & Schwarz Group, leads Aldi in France and Britain and is moving into Eastern Europe, where Aldi is so far absent. "I think they'll be challenged to extend their footprint any farther," says Richard Hull, who heads the retail team at London consultants Cap Gemini Ernst & Young Group.

Aldi's all-cash approach to expansion means risk is low. Analysts say Aldi could find a niche in U.S. markets that can't support a "big box" store such as Costco Wholesale Corp. And most U.S. retailers don't seem to recognize the threat. "[Aldi] is kind of bottom-feeding, and nobody notices it," says Tom A. Muccio, a former Procter & Gamble Co. (PG ) executive. Funny, that's the same mistake that German competitors made a few decades ago.

By Jack Ewing with Andrea Zammert in Frankfurt, Wendy Zellner in Dallas, Rachel Tiplady and Ellen Groves in Paris, and Michael Eidam in Smyrna, Ga.

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