Grocery chains are being squeezed from all sides

Pressure from consumers, discounters and Whole Foods will hurt smaller grocery chains

The next top players in the grocery business may feel more like survivors than winners.

The industry is trying to keep up with rapidly changing consumer tastes. But new competition, ranging from European discounters like Aldi to Amazon’s Whole Foods, will leave even the best-positioned supermarkets struggling for growth.

The big losers will be regional chains, which account for the bulk of sales in the U.S.’s highly fractured supermarket industry. Already this year, chains such as Tops Markets and Southeastern Grocers, the owner of Winn-Dixie and BiLo, have filed for bankruptcy.

Aldi and fellow German discounter Lidl have wreaked havoc across Europe. In the U.K., where Tesco used to be so dominant locals called it “Tescopoly,” the discounters defeated both Warren Buffett and Walmart. Mr. Buffett famously called his $2.3-billion (U.S.) investment in Tesco a “huge mistake” and Walmart sold its struggling U.K. chain earlier this year.

The same discounters, which cut prices by focusing on a limited range of mainly private-label products, now have their sights on the U.S. Aldi has committed roughly $5 billion to upgrading and expanding its stores. It wants 2,500 locations by 2022, up from roughly 1,700 now, excluding the almost 500 Trader Joe’s stores owned by an Aldi sister company. Lidl is much further behind, having opened its first U.S. stores last June.

The most likely victims of their expansion aren’t Walmart and Kroger, the No. 1 and No. 2 chains in the U.S., but the smaller chains that still dominate U.S. food retail. In the U.K., the top four chains account for almost two-thirds of grocery sales; in the U.S. the figure is 42 per cent.

Walmart and Kroger have the resources to fight back. But they had grown by taking market share from smaller players, which will be harder with Aldi and Lidl trying to expand.

In an interview, Kroger Chief Financial Officer Michael Schlotman said the chain can compete on more than price, citing its prepared foods and instore restaurants, online ordering and in-store pickup system and customer loyalty programs. “We started competing against Walmart in 1992,” he said. “There’s always been people out there competing mainly on price, offsetting selection and experience.”

A key growth opportunity for U.S. chains is private-label brands, which account for only around 15 per cent of packaged food and household products, compared with over 40 per cent in the U.K, according to Nielsen. Margins on these private-label goods are several percentage points higher than on other goods, Mr. Schlotman said. Kroger’s private-label sales are up 40 per cent over six years, and now account for almost 30 per cent of unit sales.

Among the most promising private labels is Whole Foods’ 365 brand, which Amazon has tried to grow online. If Amazon can grow Whole Foods’ private label broadly, the impact will be felt in high-margin products such as organic groceries and prepared foods.

The losers in the grocery business will be consumer brands like Kraft Heinz, which are hurt by private-label goods, and smaller chains, hurt by the discounters. Big supermarket groups should do better, but it will be hard to match the growth rates of the past.