Sainsbury's and Netto should have known better over doomed joint venture

Last week’s Grocer article about the financial cost of the failed joint venture between Sainsbury’s and Netto reaching £40m will have come as no surprise to anyone involved in starting a discount food business in large competitive markets.

Perhaps the most surprising issue is that the statements made by both parties seemed to indicate it was not expected. Well, it really should have been. There is a reason why there are only two globally successful discount operators in the world: it costs a ‘boatload’ of money to start that kind of business in a new market.

I really can’t understand that it was not obvious to Sainsbury’s because there are plenty of people they could have asked. But Netto’s excuse is just as unbelievable: they are a discounter and they’ve been to the UK before.

My estimation of investments needed in any new market the size and competitive level of the UK that a discount operator has to make before it will see any meaningful return is 10 times that amount, at £400m.

The investment in purpose-built stores and distribution centres to get the operational cost levels necessary, along with the building of a private label supply chain scale, quickly consumes my £400m. Especially as you still need to set the retail price of your product at a minimum level of 20% below the full-line supermarket equivalent. Otherwise the consumer won’t find it attractive enough.

Perhaps Netto could have brought product from their home market? No! Food is like language; it belongs to the country it is practised in. So other than maybe Danish butter cookies at Christmas that could never have really worked. The early days of Aldi and Lidl were littered with consumer rejection; not because a product wasn’t cheap enough but because it didn’t taste or perform like the brands the consumer was previously buying. The early assortment, mostly sourced from France or Germany, were not even bad quality, just different. Customers don’t change their dietary habits that quickly. Not until Aldi or Lidl had the scale of the big four UK retailers’ purchasing power and were able to ensure mostly UK-sourced products and everything the British consumer required of their range were they really successful. This takes scale, which in turn requires time and money, hence £400m.

Why then was it not possible to use Sainsbury’s supply chain to create the right range? Close examination shows Sainsbury’s will earn approximately 25% margin in its current business on the typical high volume assortment sold at supermarket but also suitable for a discounter. That’s got to be sold 20% cheaper to work in a discount environment - you see my point.

With 350 to 400 stores, volumes of the relevant discount assortment would probably have doubled (as a discounter has much higher sales per product than a supermarket), but 350 to 400 stores cost money to acquire. Anything less and the necessary scale just isn’t there! So if both parties really only planned to put £40m in the pot, I’m sorry to say that it was a failure waiting to happen.

Paul Foley is a partner at Foley Retail Consulting and former CEO of Aldi UK