"The company that doesn’t pioneer doesn’t take chances and merely goes along with the crowd is liable to prove a rather mediocre investment in this highly competitive age."Â –Â Philip Fisher
Readers of my articles are well aware of my affinity for investing in the “ugly ducklings” of the stock world. I am drawn to companies which trade at a sizeable discount to their net assets (either overt or covert); such entities generally hold a significant margin of safety. That said, successful investors should always take an eclectic view in regard to their portfolios and the ability to spot superior business models can result in material long-term capital gains so long as the security is purchased at a reasonable price.
Superior business models allow companies to compound high returns on capital over long periods of time which is the essence of a successful “buy and hold” strategy. Transcendent business models allow a company to produce higher margins which results in greater profits as well as the ability to reinvest its profits at high rates of return. The efficiency in which a company generates its profits frequently determines the company’s ability to expand its earnings. Further, if rival companies continue to employ traditional business models, the competitive advantage of the superior business model is likely to endure for a significant period of time.
Examples of innovative business models include: online shopping evolution, drive-through windows at fast food restaurants, circumventing traditional cab companies by accessing Uber, a near ubiquitous ability to access the internet through mobile devices, and more recently, the development of the internet of things.
Today’s article will profile an innovative low-tech business which has created a business model which allows them to sell their products at lower prices and turn their inventory much more rapidly in the mundane world of grocery shopping. Unfortunately, the company is not publicly traded thus any profits accrued from the discussion to follow will be merely intellectual in nature. The name of the business is ALDI.
The ALDI business model
Most traditional grocery stores are plagued with inherent inefficiencies which virtually insure low profit margins. The typical store carries an exhaustive inventory, suffers from a bloated payroll while maintaining store hours that focus upon customer convenience rather than profitability. Additionally, grocery stores tend to be so large that locating specific merchandise can become a daunting task for the customer. Keep in mind that spacious stores ante up mightily for lease and utility expenses to finance the right to become one-stop shops which operate 24/7.
The traditional method of luring customers involves heavy advertising through the local print media which features sales on a few items (sold at or below cost) in hopes that the customers will fill their carts with profitable items along with the discounted ones. Few concepts in American business have been more enduring than this “loss leader” strategy; although savvy shoppers such as my wife load up on the bargains while leaving the remainder of their shopping carts barren.
Many grocery stores still sack your purchases and provide customers with easy access to shopping carts which may or may not be returned to their proper areas. Additionally, most stores are forced to employ help to retrieve the carts and resituate them at the entrance of the store.
The ALDI business model employs a methodology that aims at achieving the holy grail of retailing: specifically, realizing high inventory turnover and maximizing sales per square foot. Inventory turnover is particularly important in the grocery business since many items are highly perishable. High sales per square foot maximize profitability while minimizing operating costs which results in a lower price for consumers.
According to the ALDI website, their stores achieve the aforementioned advantages by employing the following methods:
- Customers bring their own bags or buy our reusable bags to save money.
- Modest store size plus eliminating non-essential grocery store services means ALDI captures the very essence of conservation and savings for customers.
- In-house distribution network streamlines operations and maximizes efficiencies resulting in even greater saving for customers.
- Innovative cart rental system helps keep prices low and eliminates time spent retrieving carts.
- Specially designed packaging doubles as product displays, saving time and money on stocking and replenishment
- Not operating 24 hours a day lowers labor, energy, and rent costs, with savings passed on to customers
ALDI also sells their exclusive brands (over 90%) which are attractively packaged and resemble popular name-branded products. These brands are designed to deliver savings to the consumer while maintaining high quality. The company also claims to utilize large-scale concentrated buying power to create operating efficiencies.
Analyzing the ALDI business model
As I alluded to earlier, superior retailers focus on rapid inventory turnover and high sales measured in terms of square foot areas. Obviously, all retail operations pay particular attention to insure that its retail space is not being encumbered by slow-moving merchandise. So the question remains: Why do so many grocery stores contradict the “prime directive” of successful retailing?
I believe that the answer lies in the archaic belief that price is a secondary consideration for most grocery shoppers. The old axiom holds that store appearance, customer service and convenience rather than price, are the primary considerations of grocery shoppers. It should be noted that I have talked with several acquaintances that refuse to shop at ALDI after witnessing some poor quality produce on display; however those complaints seem to have little effect on overall merits of the company.
The business model of ALDI is reminiscent of the original strategy of McDonald’s (MCD, Financial) which focused upon successfully reproducing a limited amount of popular products without regard to the location of the property. It would seem that such a strategy would produce a durable competitive advantage so long as the retailer could maintain their position as the low cost provider of a stable of high-quality products which the consumer demands. Breaching the moat would require a well-capitalized competitor to employ a similar strategy; certainly a possibility but one which would likely cause a great deal of angst among the management and boards of traditional grocery chains.
The success of the ALDI model represents a more efficient method of moving high-demand merchandise by systematically reducing operating costs, creating attractive branding which is displayed in easy to find locations and creating economies of scale by utilizing effective distribution and sourcing practices.
The significance of understanding superior business models
Many value investors are privy to the frequently told story of Warren Buffett’s purchase of See’s Candy back in the early1970s. Buffett often refers to the purchase as an epiphany in his investing philosophy. The unique business model of See’s featured little in the way of overhead, coupled with a brief selling season and a rapid turnover of a limited inventory. Further the company sold its goods for cash which eliminated accounts receivable. Additionally, the popularity of the candy on the west coast and the brand loyalty allowed the company to consistently raise prices and achieve incredible returns on invested capital which would not dissipate over time.
Certainly, most investors will never run across a See’s candy in their investing careers; however they are very likely to witness a number of innovative business models. Only a few of these unique business models will be worthy of investment as most of them will likely be transitory in nature and many others will be outrageously overvalued. That said, it only takes one inspiration which results in great buy and hold investment to make a significant difference in the quality of one’s retirement. Just check out a long-term chart of McDonald’s and you will see what I mean.
