Insurgent Grocer Aldi Shows the Brutality of Disruptive Innovation
Disruptive competition shakes up stale markets and drives a lot of consumer benefits. It can also lead to painful transitions, put long standing companies out of business, impact employment, and rock industries. These transitions are often temporary, and markets tend to settle leaving consumers much better off than before. This can make disruptive competition challenging to assess, from a policy perspective, because its impact is varied.
One of the best disruptive competition stories concerns a grocery chain called Aldi. Aldi is an example of true disruptive innovation, as coined by professor Clayton Christensen. Disruptive innovation is a term of art used to describe a specific disruption model where a new company enters and succeeds in a market by targeting overlooked or unserved customers, usually customers at the low end of the market. Disruptive competition, as used on this blog, is an umbrella term used to describe all forms of disruptive entry, while disruptive innovation describes a specific strategy that allows new entrants with fewer resources to challenge successful incumbents. A disruptive innovator can capture a foothold in a market by winning underserved customers and then building on that success to challenge powerful incumbents for customers traditionally served by the incumbent.
Disruptive competition includes disruptive innovation, but much disruptive competition cannot be accurately called disruptive innovation. For example, the iPhone was disruptively competitive and upended markets. However, it was not disruptive innovation because the iPhone targeted the high end of the market that was already being served. This new smartphone market actually set the stage for a disruption that better fits the disruptive innovation label. Android was released for free to all smartphone manufacturers, which made it easier for them to make smartphones targeted at the low end of the market. This strategy allowed companies to challenge the iPhone. Android now dominates in overall sales, yet Android still lags in the upper market sales that drive app store revenue.
So how does Aldi fit into this story? Aldi has focused on brutal process innovation to generate savings and pass those savings on to customers. It is so good at this that not even Walmart, widely regarded as being one of the best companies at using scale and technology to drive down prices, can compete. In March 2019, a basket of 40 common goods at Aldi was $55.83 and yet $68.16 at Walmart. This brutal efficiency has allowed Aldi to capture the low end of the market, and it is also attracting some higher income customers as well.
Aldi succeeds by being dramatically different than its competition. For example, Aldi keeps its labor needs incredibly low and may only have 15 to 20 people total working each store. They use quarter deposits to encourage customers to return their own carts, they hire no grocery baggers which means customers bag their own groceries, most items are stocked in their original shipping box, and they are in smaller stores with fewer product options.
This worker displacement presents a policy issue: isn’t lower employment a bad thing? However, Aldi reportedly pays its employees better than the industry average and is still able to offer rock-bottom prices. This is probably due to the fact that its process innovation allows it to get more done with less workers, and Aldi can share that increase with its workers. It can be difficult, as a policy matter, to decide whether policy should maximize for more jobs or better jobs when it is unlikely that the market can support both.
More than 90% of the brands Aldi sells are private label, and many product categories don’t have what we would traditionally think of as competition on the shelves. These private label products are often produced by the same companies that sell the popular competitive brands you would see in other stores. Aldi is able to offer these unbranded products for cheaper for two reasons: 1) Aldi can offer the manufacturers the exclusive or near exclusive right to sell products in each category on the shelf; and 2) the (mostly secret) manufacturers don’t have to worry about undercutting their own brands in other stores because their products are being sold under a different label. These in-store exclusivities may sound bad, but Aldi is fiercely competing with other grocers and this competition is driving it to provide low prices without sacrificing much in the way of quality. Again, it’s difficult to judge whether it’s better to have more choice or better prices (the research on choice also shows interesting results).
If Aldi’s private label strategy sounds a bit like Trader Joe’s, then it may not come as a surprise that Trader Joe’s is owned by the same family that owns Aldi grocery stores: Aldi Nord. Trader Joe’s has a similar strategy as Aldi in using private labels and fewer options to control costs. A key difference is that Trader Joe’s hires many more people than the average grocer and puts positive customer interactions as the top priority. Trader Joe’s is also aimed at a higher end of the market. Both grocers are incredibly successful, and Trader Joe’s earns the highest revenue per square foot in the industry by a wide margin.
It’s easy to look at the success and popularity of companies like Aldi or Trader Joe’s and ignore the fact that disruption has costs. For one, the new business model simply has less stakeholder participation. The private label strategy means that less companies can sell their goods in these stores and those that do generally have to do so under the store’s name. In Aldi, there are less jobs for employees. The market also doesn’t have much room for the mediocre when top grocers are fiercely competing like this. Second- and third-tier grocers are going out of business. This means displaced workers and a blow to the vendors and even the real estate owners that were relying on them.
Disruption can be brutal, and there is often a good reason to take a close look at, and potentially address, the consequences it creates. It also makes little sense to vilify the disruptors, who are often driving tremendous consumer value and benefit. That’s just the nature of disruptive competition. The automobile practically killed the horse buggy business. While it may make sense to pursue policies to accommodate those on the losing end of socially beneficial disruption, it doesn’t make sense to solve these problems by unmaking progress.