#77 Business Model Breakdowns: Hard-Discounters

Building a Business on Thin Margins and Big Returns

Retail is brutal. The competition is relentless, the margins are thin, and the barriers to entry are almost nonexistent. Anyone with a storefront and a cash register can jump in, but most don’t last. Yet, hidden in this brutal landscape, there are a few rare gems that, when executed well, can compound value over decades.

One of these models is the hard discounter. Simple, scalable, and ruthless in its efficiency, hard discounting has reshaped grocery retail in Europe and is starting to make waves in other parts of the world. Companies like Aldi, Lidl, and Action have shown how focusing on low prices, private labels, and economies of scale can disrupt entire markets and deliver exceptional returns.

In this article, we’ll break down the hard discounter model—why it works, the challenges it faces, and what conditions make it thrive. If you’re looking for a blueprint to identify the next big opportunity in retail, this is it.

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The Flower Market by Victor Gabriel Gilbert (XIX century)

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1. Retail: A Graveyard of Ideas, but the Right Models Shine

Retail can produce incredible compounding returns when the model is scalable, but let’s be clear: this is a very, very difficult business to run. Why? Because everyone can see what’s working. There’s nothing easier than opening a store and copying an idea. Think about it—any drunken idea could be to start a retail business. A bar, a restaurant, a nightclub—they might do great, but let’s be honest, they’re extremely hard businesses to operate. The competition is endless.

1.1 Key Takeaways About Retail

1. Retail is, generally, a terrible business: The sheer ease of entry and the level of competition make retail a graveyard for many ideas.

2. Even the best retail businesses hit a wall: Successful retailers like Starbucks or Ulta Beauty eventually saturate their markets. When growth slows, the stock price typically suffers because the market thrives on expansion.

3. Always adjust same-store sales (SSS) for inflation: Especially in emerging markets, inflation can distort growth. Take Dino Polska, for example. Many touted 25% same-store sales growth, but inflation during that time was around 20%. Real growth? Barely noticeable.

Also, keep in mind that when a retailer’s base of mature stores is small compared to the number of new openings, SSS will naturally look high because new stores ramp up sales quickly until they stabilize. This isn’t extraordinary—it’s just normal.

4. Return on capital for new store openings matters: There’s a world of difference between a retailer generating a 15% return on a new store versus one generating 100%, or even models where there is no incremental capital required.

5. Quality of demand is critical: Not all retail demand is created equal. Selling groceries (essential, daily demand) is vastly different from selling construction materials (sporadic, project-based demand) or electronics (discretionary, one-time purchases). One provides recurring sales, the other doesn’t.

Retail, in general—and let me emphasize this—is a terrible business. If you have any doubts, it’s better to stay far away.

If you want a more detailed breakdown of the retail business model, you can check out my previous article:

2. Hard Discounters: A Simple but Potent Business Model

Hard discounters operate with one of the simplest retail strategies: offer the lowest prices by cutting costs wherever possible. The model is lean, aggressive, and, when done well, incredibly effective. Examples like Lidl and Aldi have dominated the food retail space with this approach, becoming household names across Europe and beyond. But the model isn’t limited to groceries—non-food hard discounters like Action, backed by private equity firm (public traded) 3i Group, have shown that the same principles can disrupt other sectors. Action has grown rapidly in Europe by applying the same low-price strategy to household goods, becoming a market leader and delivering remarkable returns for its investors.

These examples highlight why hard discounters are so fascinating: they thrive in competitive, low-margin environments where many businesses fail. Their simplicity is their strength.

2.1 Key Features of the Hard Discounter Model

At the heart of the hard discounter model are two key pillars: low prices and private labels.

1. Low Prices Above All Else

The foundation of hard discounters is to offer the lowest prices in the market. To achieve this, they save costs in every aspect of their operations:

• Simple, warehouse-style stores with minimal decoration.

• Limited product range (typically 800–2,000 SKUs vs. 20,000+ in traditional supermarkets).

• High inventory turnover to reduce waste and optimize working capital. This, together with onerous payables to providers, lead sometimes to models with very large negative working capital → suppliers financing new store openings → no capital required to grow.

2. Private Labels (Store Brands)

Hard discounters rely heavily on private label products, often accounting for 80% or more of their assortment. These products allow them to bypass the traditional healthy margins of large consumer goods companies like Nestlé or Unilever, offering comparable quality at 10–40% lower prices.

Private labels do more than cut costs—they build customer loyalty. Aldi and Lidl, for example, offer guarantees that encourage customers to try their store brands, often finding them just as good as—or better than—branded alternatives.

3. The Critical Role of Suppliers

To sustain this model, hard discounters must build strong relationships with their suppliers. But this is easier said than done.

Tight Margins, Big Expectations: Hard discounters demand low prices from suppliers while asking them to grow production at the same pace as the retailer. Many suppliers are small businesses, not equipped to handle 20-30% annual growth, especially when payment terms often stretch to 60 days or more.

Furthermore, the relationship between hard discounters and their suppliers is a delicate one. While retailers must push for lower costs, they also need to support their suppliers’ growth—sometimes by financing equipment purchases or offering long-term contracts. This balance is essential to ensure supply keeps up with demand.

3.2 Market Entry Conditions for Hard Discounters

A few years ago, the former CEO of Aldi UK shared a fascinating story about how Aldi decides where to expand. It was part of an interview on InPractise (which, by the way, is free and absolutely worth reading). He explained how Aldi systematically evaluates potential markets—step by step, condition by condition—like an engineer designing a machine.

It struck me because the approach is both methodical and ruthless. It’s not about chasing buzzwords like “disruption” or “innovation.” It’s about seeing if the basic ingredients for success are there and, if so, moving in with precision. And yet, despite the simplicity of the model, there are still markets in the world where hard discounters haven’t taken hold.

Even Spain, a relatively mature retail market, didn’t have a true hard discounter until recently. Mercadona isn’t a pure example—it’s more of a hybrid—but it shows how the principles of simplicity, cost control, and private labels can dominate a market when done well.

So, what are the key conditions for launching a hard discounter in a new market? Let’s break it down.

The Aldi Playbook for Expansion

Step 1: How Many Players Are in the Market, and What’s the Penetration?

Imagine you’re Aldi, scouting a new region. The first thing you’d ask is, Are there any hard discounters here already? If the answer is no, you’ve cleared the first hurdle.

“The first is probably obvious. They’re looking at the discount penetration. If there is none and when Aldi was looking at the UK, there was just a firm called: Quick Save that seemed to be struggling a little bit in its positioning and its success. That was it. There was no other player on the market, and they had around two and a half percent of the market. Discount penetration is a critical first factor.”

Step 2: Are Existing Supermarkets Making Too Much Money?

Here’s where it gets interesting. Hard discounters thrive in markets where traditional supermarkets are over-earning.

When Aldi was considering the UK, they noticed that the big chains—Tesco, Sainsbury’s, and Asda—were reporting EBITDA margins over 10%. That’s double the global average of 5%. It was a sign that supermarkets were charging too much, and customers were willing to pay it because there wasn’t a cheaper alternative. Aldi knew they didn’t need to work too hard to undercut those prices and attract customers.

“Number two is that you’re actually looking at how rich and successful the industry is. To give you some benchmarks and examples. Across the world, on average, a good food retailer can earn five percent EBITDA and three percent net profit. If you’re anywhere above that, the industry would be considered rich. When Aldi entered the UK and was doing its market entry study, most of the good players who were dominant on the market had actually double-digit EBITDA figures, more than ten percent. Double what the global average was. What that actually means is that they had relatively high prices. They could get away with that, the customer was quite happy to pay those prices because they were good operators and because there wasn’t any alternative. The customer could afford it, too.What that means for a discounter is it will not have to invest so much money to be significantly cheaper than the incumbent on the market.”

Step 3: What Is the Wealth Profile of the Population?

Hard discounters don’t work everywhere. They need a very specific kind of customer base: people who have enough money to care about quality but still need to stretch their budget.

This is why hard discounters thrive in places with large middle- and lower-middle-class populations. These are people who can’t or won’t pay for premium brands but also expect good value for their money. Aldi’s former CEO described it as targeting a population that’s been “wealthy enough for a generation” to demand decent quality but frugal enough to seek out savings.

“The third element is that you need a consumer who’s been by global standards, let’s talk GDP per capita, rich for a generation. What happens when you have that kind of situation is people have expectations of what they consume. They are not willing to eat things that they don’t like just to get enough calories inside them. They have enough money to be able to consume exactly the quality level and the taste profile that they’re either used to or want. Furthermore, the postman and the hedge fund manager, at the core of the diet basically eat the same things. Same cornflakes, same jam. Same milk, same beer. Same cheese. Same bread. All the core of the diet is pretty consistent irrespective of what you’re earning. It only diverges when you talk about niche products. The postman is not buying champagne every week, but that’s not the core of the diet either to be honest. This is very important to a discounter and why? Because a discounter wants to come with one product in every particular category. Not a wide choice of product, but one product and it’s got to appeal to the majority of people in order for it to be successful.”

Step 4: Are Incumbents Publicly Listed?

This might seem like an odd question, but it’s critical. Publicly traded companies have one big weakness: their obsession with quarterly results.

Imagine you’re the CEO of a large supermarket chain, and a hard discounter enters your market. You know they’re a threat, but what can you do? Slashing prices would cut into your margins and send your stock price into free fall. Expanding into hard discounting yourself would mean abandoning your dividend policy and alienating shareholders.

So, what happens instead? Nothing. Most public companies wait too long to react. By the time they wake up, the hard discounter has already gained a foothold.

It’s a strange dynamic: the more “professional” the competition looks on paper, the easier it is for a hard discounter to disrupt them.

Why This Matters

The hard discounter model might seem simple, but its success depends on finding the right conditions. The absence of competition, a large price-sensitive population, fat margins from incumbents, and a slow-to-react competitive landscape—all these factors make or break an expansion.

“Finally, as a hope, I would say, a discounter like Aldi when entering a market would prefer that its competition is stock market listed. Stock market listed companies have programs, management incentive schemes, which means that the management is not likely to react to a new threat until the last minute. They’re whole compensation package, what is expected of them as a management team, their contracts, their job descriptions are all based on maximizing shareholder value, maximizing profits. Taking some threat 15 years into the future and trying to cancel it out now by reducing your prices and reducing your profit, that’s just not on the agenda of a publicly run company before it has to. It buys the discounter a period of time of going under the radar. Nobody takes any notice of it until hopefully from the discounter’s perspective, it’s too late. These are the criteria that somebody like Aldi is looking for.”

What makes this story fascinating is that even today, there are still markets where these conditions exist.

3.3 Building a Hard Discounter: Challenges for New Entrants

The hard discounter model is straightforward: sell good products at the lowest possible price and do it profitably. But here’s the catch—this simplicity sits on thin margins. It’s a business where every penny counts, and even small mistakes can have outsized consequences.

The entire model hinges on a delicate trade-off. Lowering prices drives customer growth but cuts into profits. Pushing suppliers too hard risks breaking those relationships, yet without pressure, costs creep up. This constant balancing act defines the hard discounter business: a tightrope walk between growth, value, and profitability.

Now imagine trying to build this from scratch. Where do you begin? How do you develop private labels that people trust? Who will supply you, and how do you get them to believe in your vision?

1. Sourcing and Developing Private Labels

Every hard discounter starts by answering one crucial question: What’s on our shelves?

In the early days, most new entrants can’t negotiate with big suppliers. They have no scale, no reputation, and no guarantee of success. So, they look elsewhere—often abroad or to smaller, less established suppliers. But this comes with challenges:

• The products may not match local tastes perfectly. Imagine launching a line of coffee in Italy that doesn’t taste right—it’s game over.

• Costs can be higher, because these suppliers are also taking a gamble on you.

The CEO of Aldi UK described how, in their first year, they spent months convincing suppliers to work with them. For some, they even helped buy machinery to produce private-label goods. “We had to tell them: trust us, we’ll grow together,” he said. And that’s the key—hard discounters don’t just buy from suppliers; they build partnerships, often financing growth and committing to long-term contracts.

But there’s a payoff. As the retailer scales, it can renegotiate better terms, source locally, and launch products tailored to the market. Over time, those private labels become a weapon. They’re cheaper, just as good as big brands, and keep customers coming back.

2. Building Supplier Relationships

Every supplier conversation starts the same way: “We need the lowest price.” That’s the hard discounter’s promise to its customers, and suppliers must make it happen. But for many smaller suppliers, growing at 20-30% a year while waiting 60 days for payment isn’t easy.

One story illustrates this perfectly. Early on, they partnered with a local snack maker. The supplier had only one small factory and struggled to meet the retailer’s demand. To help, the discounter offered to prepay part of the contract and connected them with a bank for financing. Within a year, the supplier had doubled their production and was thriving.

This balance—pushing hard on cost while helping suppliers grow—is critical. Without it, supply chains break down, and the whole model collapses.

3. Achieving Scale

A hard discounter without scale is like a car stuck in first gear. It might move, but it’s inefficient and exhausting. The model only works when costs are spread across a large base of stores, and suppliers produce at high volumes.

But the path to scale is anything but smooth. In the early years, margins are razor-thin, and cash flow is tight. “Every store we opened brought us closer to profitability,” he said. “But until we hit 100 stores, we were losing sleep over every expense.”

3.4 The Trade-Off

Building a hard discounter is like spinning multiple plates at once, with everything hinging on a single, powerful principle: economies of scale. The larger you grow, the more efficiently you can operate, but reaching that scale requires balancing competing priorities:

• Keep prices low to attract customers: Growth depends on delivering unbeatable value, which means cutting costs relentlessly while still meeting customer expectations.

• Push suppliers hard while helping them grow: Suppliers are critical partners in achieving scale, but they must expand production as fast as you do. This requires careful collaboration—pressuring them on price while supporting their long-term growth.

• Reinvest profits wisely: Every dollar of profit must be reinvested into opening new stores, improving operations, and lowering prices further—all while keeping shareholders on board with the long-term vision.

At scale, these trade-offs become self-reinforcing. Lower costs drive lower prices, which attract more customers and increase sales volumes. Higher volumes, in turn, improve supplier efficiency and reduce costs even further.

Successful retailers are rare. The harsh reality is that most retailers fail sooner or later, and only a select few manage to thrive over the long run. The same applies to hard discounters. There are only a handful of publicly traded hard discounters globally, and that’s no coincidence. This business model requires an intrinsic commitment to the long term—a perspective that many companies, especially those beholden to quarterly results, struggle to maintain.

For patient investors willing to think long-term, hard discounters offer a rare opportunity to capitalize on a simple but potent model. The challenge is finding the right market and management team to execute it. The reward? Potentially compounding value for decades.

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