Discount Retail Chain Lidl`s mother company the German Schwarz Group (Schwarz Produktion Stiftung & Co. KG) has been expanding its food production capacities for articles from the compulsory range for years. It started with MEG (1,500 employees/MA) and non-alcoholic beverages. In the following years, Solent (350 employees) with chocolate and snacks, Bon Back (700 employees) with frozen baked goods, Bon Gelati (500 employees) with ice cream, Bon Presso with coffee and Bon Pasta with pasta were added.
The turnover in production is estimated by German Lebensmittel Zeitung (LZ) at 2.5 billion euros. With Lidl's sales of 114.8 billion euros worldwide in 2022 and an estimated 75% COGS (Cost of Good Sold = cost of goods), production accounts for only about 3% of the cost of goods and shows the further potential of a verticalization strategy. A comparison with Migros production in Switzerland is worthwhile. Sales in the production of private labels in 2022 amounted to CHF 5.8 billion. This means that verticalisation is at the forefront of Migros worldwide.
The mandatory assortment in the food retail sector is characterized by high turnover speeds and rather below-average trading margins and represents 55-60% of total sales. This verticalization strategy has absolute cost advantages through economies of scale, in-house learning curve, and faster ways to respond to trends with product innovation. In addition, there is an increasing desire to become independent of suppliers in the production of private labels.
The prerequisite for economic success is maximum utilization of the capital-intensive production facilities with high fixed costs. When it comes to verticalization, the Schwarz Group focuses on both an independent development of production (e.g. coffee roasting company Bon Presso) and acquisition (e.g. Erfurt pasta with 170 employees). In the case of the construction of new production capacities, the aim is to achieve the minimum optimal operating size (MOG) with the lowest unit costs in order to achieve cost leadership. In the case of coffee roasting, a large scale entry can be assumed. The newly built capacity of Bon Presso is expected to be 50,000 t, with coffee sales in Germany of 345,000 t in 2020. As a result, market conditions are changing dramatically. Overcapacities will arise and weaker suppliers will be forced out of the market in the medium term. For example, Aldi Nord closed its rather small coffee roastery (60 employees) in Herten in June 2022. Aldi Süd will follow at the end of 2023 with its roastery in Mühlheim (MA 70 employees). Production will be bundled in New Coffee GmbH (160 employees) at the Ketsch site from 2024, where production has been carried out for Aldi since 1973. Consequently, Aldi is also trying to implement the MOG. The production volume is stated to be 35,000t, which corresponds to about 10% of consumption in Germany.
The existing providers could have prevented the entry of a large provider through limit pricing. In industries with economies of scale, an intruder can be fended off by preventing them from achieving an optimal business size. The addition of the MOG of the previous market participants corresponds to the demand at the current price level (limit price). There is no demand for another supplier to the MOG. Prices would have to fall significantly on the market. In the case of the coffee roastery, however, this limit pricing strategy could not prevent entry, as the Schwarz Group was confronted with not too little demand, the demand comes from Lidl and Kaufland from its own group.
In addition to pure economies of scale, efficient production of smaller batch sizes has become very important in production. For example, MEG supplies non-alcoholic beverages with 300 different items to Lidl and Kaufland in 25 countries. Throughout Europe, there is a great depth of assortment in the assortment that has to be served. Production for third-party customers who are not in a competitive position with Lidl or Kaufland would also be conceivable in the future. For example, Aldi Süd and Nord both sells their own private label produced coffee to all its European markets and the USA, to all their Aldi national companies active in these countries.
The disadvantage of verticalization is the high long-term capital requirement with currently high variable and fixed interest rates for the necessary financing and the high fixed cost block. A lack of know-how in production is not an issue in the Schwarz Group. Production knowledge at Food is available.
Founded in 2016 and starting production in 2018, ARTiback (150 employees), a producer of frozen bakery products with a focus on specialities, already supplies Lidl and would well complement Bon Back's own production capacities, where the baking classics have been produced on the baking shelf since 2012. Production is very capital-intensive, with fixed assets at ARTiback amounting to EUR 32 million with a gross profit of EUR 15.9 million, according to the last published annual financial statements for the 2021 financial year. The economic situation of ARTiback, with high loss carryforwards from previous years, has so far been characterized by rapid business expansion and start-up losses, although the operating cash flow is now clearly positive at EUR 3.0 million. At EUR 0.1 million, the profit is more likely to be in the black. At the end of the financial year, equity amounted to only EUR 1.8 million.
The equity ratio of 5.2% is therefore very low and certainly does not allow for further expansion without new investors. So far, financing has mainly been provided by banks. The Schwarz Group is now the financier for further expansion. However, the purchase price quoted in the LZ in the double-digit million range seems very high given the low equity. ARTiback has not only supplied Lidl in the food retail sector. After the takeover, these dealers will have to look for new sources of supply. Aldi Süd with "Meine Backwelt" is not affected by this in the listing according to Storecheck in Heilbronn. The frozen bakery products are sourced from a variety of other suppliers. In addition to more than 60 regional bakers for fresh products, the top dogs Harry Brot, Lieken and Aryzra Backeries will be there. The large number of suppliers at Aldi Süd is surprising and points to a tendency towards higher process costs.
There is no sales risk for frozen bakery products in the future. Consumers will continue to shift their bakery purchases even further to the baking stations of food retailers. The discounters are currently the winners, 39% of the Bach goods are sold at discount according to Gfk figures. Sales increased by 22.5% and volumes by 5% compared to the previous year. It is also predicted that there will be a trend towards regionality, sustainability with higher value, more variety of product ranges and individualised products with lower production volumes. With ARTiback, the Schwarz Group secures additional capacities and competencies in specialties.
It is important for the long-term strategy in the Schwarz Group that further strategic investments are made in the business areas that currently generate the cash flow and not only in new business areas such as IT security, container shipping and cloud business. The cash cow in the Schwarz Group continues to be Lidl with its foreign subsidiaries and Kaufland Eastern Europe. The production of the mandatory assortments reliably strengthens these cash flow generators. At the moment Aldi Nord is also speaking with multiple suppliers for a take over one of them is the large German juice supplier riha WeserGold as a potential target.
