Albert Heijn Price War among Retailers (A) BY WOUTER H. DESSEIN' AND REMMELT DE JONG* Introduction In October 2003 senior executives at Albert Heijn (AH), then the leading Dutch supermarket chain, announced the largest price cuts in the company's 116-year history. Effective immediately, prices would be cut up to 30% on over 1,000 items, including soap, condiments, coffee, beer, rice, meat, baby food, and other everyday grocery products. According to analysts, the announcement of forthcoming widespread price cuts \"surprised\" and even "shocked\" some competitors, who were more inclined to expect price cuts from so-called discount supermarket chains. Its rivals did not expect major cuts from the industry leader in the Netherlands, particularly as AH had developed a reputation as a relatively high-margin operation. One month earlier, AH management had announced that its Dutch market share had \"shrunk in the first half of the year to 26.7 percent from 27.9 percent a year ago.\"1 At the same time, they also announced 440 job cuts, as it became clear that the loss in market share would reduce sales and profit margins. Other concerns included a softening in consumer demand for food and household articles in the Netherlands, as well as increasing global competition in the industry. The announcement and subsequent implementation of the widespread cuts were expected to impact not only domestic supermarkets but also the many multinational and other suppliers to grocery chains. The list of companies that stood to be affected by these price drops included Unilever, Proctor 1- Gamble, Sara Lee, Heineken, L'Ore'al, and Coca-Cola, just to name a few. A number of questions circulated in the business press and analyst boardrooms: How long would the price cuts last, and would they become deeper over time? Would the price cuts be passed along to suppliersparticularly if the cuts took hold industry wide? Would they result in more consolidation in the industry? If so, who would stay and who would drop out? Some game-theory adherents and industry analysts raised cautionary signs about the potential for industry-wide harm if the price cuts resulted in a more sustained price war. In their article, \"The Dynamics of Price Competition,\" authors Luis Garicano and Robert Gertner state atly, "Nothing wipes out prots like price competition.\" They continue: Companies in industries such as personal computer retailing and book selling earn little money, largely because of intense price competition. ...A company considering a price cut should bear in mind the entire impact of the price cut on prots. This includes the impact of any anticipated competitive response. If a company can anticipate price matching or even a more aggressive punishment by a rival, a price cut may be unprofitable.2 Not surprisingly, immediately following the AH announcement in October 2003, industry analysts, competitors, policy makers, and indeed the global business community watched for the competitive response in the industry. What did the future hold for AH particularly and for the Netherlands' domestic grocery industry as a whole? Would the strategy, in the end, prove boldor potentially destructive and shortsighted? Dutch Fletall Landscape In 2003 The Dutch retail grocery market was led by Ahold's AH, with a market share of about 27%. Amsterdam-based Ahold also owned C1000 supermarkets through its 73% stake in Schuitema, taking another 16% of the market. At the time, AH was the premium full-service, customer- focused brand, and C1000 was positioned as a mid-market, \"down to earth\" supermarket. Laurus NV was Ahold's biggest competitor. It operated three well-known brands in the Netherlands: Super de Boer, Edah, and Konmar. Super de Boer was Laurus's high-end supermarket, with a 10% market share; Edah, holding an 8% share, was the inexpensive chain, catering to consumers with below-average income. As of 2003 Laurus was attempting to integrate a number of recent acquisitions as part of a larger company reorganization. Dirk van den Broek, owned by Uniconsult, was another relatively well-known player positioned at the mid-range price level. It covered 4% to 5% of the market. In the Netherlands, as in other developed countries, supermarkets were the most important distribution point for grocery products. The Dutch had a strong tradition of grocery retailing, with many well-known supermarket brands developing over time. In recent years, a number of Dutch corporations had begun to enter the so-called hypermarket space in response to developments in other Western European countries and in the United States, but the net result had only been a few established ventures. In the Netherlands, supermarkets focused almost entirely on sales of grocery items, such as cereals, milk and dairy products, meat and poultry, etc. Efforts to move into nonfood items had largely stalled in the country, despite the opportunity for higher profit margins typically available with such products. None of the supermarket retail brands had managed to establish an in-store presence beyond grocery items. The vast majority of supermarket retailers in the Netherlands were domestic companies. The wide range of well-known domestic brands allowed limited entry for foreign businesses. One notable failed attempt was made by Belgian retailer Colruyt, which never succeeded in attracting Dutch customers and eventually withdrew from the market. Albert Helin BACKGROUND AH was the oldest Dutch supermarket and was a core part of Royal Ahold, the Dutch retailing holding company based in Amsterdam. Ahold operated a number of retailers worldwide. Half of its activities were placed overseas, including Stop 8: Shop {and previously, US. Foodservice) in the United States. Other operations were in Scandinavia, Latin America, and Asia. The lion's share of Ahold's domestic operations were led by AH, named after the company founder. AH opened its first store in 1887 in Zaandam, the Netherlands. It was a great success, and over time AH grew to become the best-known supermarket brand in the country, with over 700 stores. Ahold also owned and operated businesses in a number of related sectors, including hypermarkets, supermarkets, convenience stores, drugstores, and Internet retailing. As of 2003 AH had been the Dutch market leader for many decades. Over the years, the company succeeded in projecting an image of a traditional Netherlands grocery shop, focusing on customer service, while also charging above- average prices to its historically loyal customer base. Although it was common to encounter private-label products in supermarkets throughout the country, AH had established itself as the supermarket that provided customers with the largest access to such products. In addition to offering well-known branded products, the company also had five different private labels in stock, covering broad price ranges and product categories. Its established private labels included AH Huismerk, AH Biologisch, and AH Express. Exhibit 1 shows Royal Ahold's private-label portfolio. LOSS OF MARKET SHARE In 2002 AH management faced a major challenge to its brand and customer trust: the revelation that Ahold had been involved in the largest accounting fraud in Dutch history. More particularly, customers and investors alike had given much attention to \"Ahold's one-billion- euros profit overstatement,"3 which was alleged to have been carried out largely at US. Foodservice. In the aftermath of the disclosures, a number of organizational changes were carried out, including replacement of the Ahold CEO and CFO. Adding to the company' s woes, the new CEO was brought in with such a high salary that consumer strikes took place. Not surprisingly, AH and other Ahold business entities suffered from customer defection and a more general decline of the company' s reputation. AH's focus on top-quality customer service and high-quality products appeared to be undercut by the accounting malfeasance. Additionally, there was a shift in the way customers perceived AH's price structure. Although AH had historically been viewed as providing good value to its customers in the middle-to- upper price range, an independent consumer interest group, Consumentenbond, challenged this notion by claiming that AH had become the most expensive retail outlet in the Netherlands. There was some disagreement about whether that was in fact the case, but regardless of whether AH had actually become the highest-priced retail grocery, that perception began to take hold in consumers' minds, and defections continued. An executive from Ahold stated, "Since the summer of 2002, there has been a negative market sentiment towards Albert Heijn due to its perceived high price level.\"'1 From September 2002 to September 2003, AH's market share fell over 1%, from 27.9% to 26.7%. In a market in which a 1% share translated into EUR 250 million, even such subtle shifts in share could not be ignored. As the industry began to experience a slight but perceptible move away from market leader AH in favor of other brands, competitors such as Dirk van den Broek began to observe upticks in sales and market position. It also became apparent that some of AH's detectors were moving to so-called discount supermarkets such as Aldi and Lidl. Lidl succeeded in actually doubling its market share by opening new stores to satisfy growing demand. At the extreme, some industry experts even postulated that growing consumer dissatisfaction with AHwhether as a result of the accounting scandal or through shifting willingness-topay profilesput the very continuation of the company's current level of business at risk. AH Price War On October 20, 2003, AH started what was internally called a price-repositioning strategy. The media and business trade publications all referred to it, from its inception, as a price war. The scale of the reduction was hard to ignore: AH management reduced prices up to 30% on over 1,000 items. It was also clear at the time of the announcement that the initial price cuts would later be followed by more, although it was unclear just how many there would be. While the industry as a whole had been enjoying good margins for years, now almost all supermarkets had to react. Prices were lowered across all brands. Product portfolios were rationalized and there were fewer and fewer products of high-quality brands on the shelves. Several rounds of price reductions followed. Laurus, with three different chains, was hit the hardest.5 Laurus immediately cut prices on 1,000 items across its three brands. At the time, Laurus's leading brand, Super de Boer, was already facing declining revenues. An Ahold spokesman stated plainly, \"Albert Heijn is by far the market leader, so when we slashed prices our competitors reacted intensely.\" Exhibits 2a and 2b show select financials for AH and Laurus from 2001 to 2003. It also became apparent that AH's new strategy was in no way a short-term approach. AH management continued to make rounds of price cuts, with reductions across 1,000 items at a time and a number of premium-priced brands simply eliminated from grocery shelves and stock. As competitors responded with cuts of their own, average price levels in the industry, adjusted for ination, dropped 6%. Laurus's CEO was quoted publicly as looking into taking legal steps to curtail the cuts allegedly on the grounds that price levels were now dipping below average cost levels. As a whole, Laurus reported losing 8.7% of turnover in the rst nine months of 2005, while the industry shed an estimated 34,000 jobs during the same period. To be sure, price reductions cut into supermarket operating margins directly, but it was also clear that a large portion of the price cuts (estimated to be from 40% to 60%) were passed on to suppliers. Thus, leading companies such as Unilever, Sara Lee, Heineken, and others also reported large job losses as a consequence of the ongoing price war. In February 2005 Unilever's CEO, Harry Brouwer, drew a line in the sand, stating, "What's currently happening is not healthy for supermarkets, for suppliers, nor in the near term for consumers. This is hurting the development of new products and marginalizes the product range in stores.\" AH in particular stuffed its stores with private-label products, resulting in lawsuits about lost sales for the A-brand suppliers. A famous legal action led to a trial between AH and Peijenburg, a supplier of breakfast products that did not want to supply AH as long as AH was keeping similar private-label products in stock. Overall supermarket sales decreased by 0.3% in 2004, and market shares were shifting in favor of AH and Dirk van den Broek. The discount supermarkets had to close stores, and AH's big competitor, Laurus, was losing money. Laurus initiated a repositioning program of its three brands, with Edah advertising itself as \"good and cheap\" (Lekker &: Laag). Laurus had to go to its shareholders to get the capital required to keep the business running. Adding to the tumult in the market was the substantial number of smaller, independent supermarkets that were beset with cash-ow challenges as a result of lower prevailing prices. In February 2004 Dutch News Digest reported, "A total of 600 of the 2,000 supermarkets in the Netherlands are threatened with closure as a result of the ongoing price war between the large supermarket concerns in the country.\"a As repeated rounds of price cuts continued, each successive round was typically led by AH and followed by Laurus brands and other competitors. This call and response pattern, however, was interrupted in August 2005 when Laurus took the initiative to reduce prices up to 30%, in anticipation of another round of cuts by year end. AH decreased prices further in October 2005, leaving industry experts and consumers dismayed over how the industry could sustain such a ferocious price war. In October 2006, fully three years after AH's first round of cuts, a company representative announced that AH would be ceasing the self-initiated price war in December 2006, providing that its competitors did not continue to drop prices. All told, AH had carried out 11 rounds of price reductions, cutting prices of over 17,000 products in the process. Exhibits Exhibit 1 Royal Ahold Private-Label Portfolio Private-Label Brand Sector(s) Notes AH Huismerk Supermarkets, hypermarkets, and convenience stores Standard range AH Biologisch Supermarkets, hypermarkets, and convenience stores Organic range AH Excellent Supermarkets, hypermarkets, and convenience stores Premium range Etos Huismerk Parapharmacies/drugstores Standard range AH Express Convenience stores and supermarkets Prepared food Euroshopper Supermarkets, hypermarkets, and convenience stores Budget range Source: Euromonitor. Exhibit 2a Select Financial Data, Albert Heijn, 2001-2003 12/31/01 12/31/02 12/31/03 Net Sales 5,409.0 5,703.0 5,606.0 Operating Income 247.0 262.0 201.0 Operating Income/Net Sales 4.6% 4.6% 3.6% Units: EUR millions. Source: Capital IQ. Exhibit 2b Select Financial Data, Laurus N.V., 2001-2003 12/31/01 12/31/02 12/31/03 Net Sales 6,401.0 5,476.0 4,065.0 Operating Income -142.0 -14.0 17.0 Operating Income/Net Sales -2.2% -0.3% 0.4% Units: EUR millions. Source: Thomson Financial