But at the Warwickshire head office of no-frills supermarket Aldi, business was booming as the unloved German discount grocer unexpectedly became a recession darling. Consumer trend-watchers talked of the “Aldi effect” and dubbed its customers the “Aldi-rati” as middle-class shoppers embraced the “hard discounters”, making £4.99 Canadian lobsters at Lidl and £7.99 bottles of Châteauneuf-du-Pape from Aldi the talk of the dinner party circuit.

The hype created a snowball effect that saw Aldi routinely chalk up monthly like-for-like sales increases of 20% – even 25% – in 2008 and 2009, an unprecedented level for a sector that rolls along at 4%.

Fast forward to 2010 and it is a different story. Aldi’s stores in UK and Ireland fell to a £58m loss last year on sales of £2bn, while its smaller Danish rival Netto has quit the country, selling its stores to Asda. Recent market share figures from Kantar show upmarket chains Sainsbury’s and Waitrose are the stars on the rise, with both chains gaining market share in the three months to 3 October, compared with the same period a year ago. Analysts say consumers have tired of austerity food shopping, with large supermarket groups reporting sales of their premium own labels picking up again, suggesting the upstart discounters may have had their day.

One industry executive believes the discounter market has a natural ceiling of 4-5% and that the chains, which had been underperforming prior to the recession, were able to play catch-up when it hit. “I can’t see any reason why the discount market would get any bigger,” he says. “Why would people seek out a limited range of brands, with names that they have never heard, at prices that are not much different to what is on sale in Asda and Tesco?”

Sainsbury’s is now the fastest-growing member of the big four (the others being Tesco, Asda and Morrisons), while Waitrose is growing at twice the market rate. Detailed figures show Aldi underperforming the industry, with its market share unchanged on a year ago at 3%. Lidl is faring better, but its share is also unmoved at 2.4%.

In a statement, Aldi’s joint group managing directors, Matthew Barnes and Roman Heini, blamed the slide into the red on a heavy investment programme: “We have invested significantly in upgrading all our existing stores and this has had an impact on the 2009 result.”

Aldi was started by Karl Albrecht and his late brother Theo, who went into business after returning from active service in the second world war. Short for “Albrecht-Discount”, they pioneered the discount format, which is based on selling fewer than 2,000 products, compared with a typical range of 20,000-30,000 in a major supermarket. The trade-off produces the high sales volumes that suppliers like, enabling Aldi to secure discounts that let it sell its mostly own brand products at rock bottom prices.

Aldi, which has approximately 450 stores in the UK, said the disposal of older stores and “surplus” assets accounted for over half of last year’s loss. In its statement it added: “We are confident our continuing investment programme will lead to both increased turnover and profitability.”

There is no doubt that the march of the “hard discounters” and the extreme reaction of shoppers to the recession caught the big supermarket chains off guard. But they mounted a vicious fightback. Tesco rebranded itself as “Britain’s biggest discounter” and slashed the prices on thousands of goods. Waitrose took the unprecedented step of launching the entry-level Essentials range.

Even at the height of the hostilities, senior executives were privately scathing of what the hard discounters could and would be able to achieve. The big four chains speak for 75% of sales, with Tesco the dominant name at 30.9%. Indeed, one senior retailer described the discounter’s growth plans as a “roundabout strategy” whereby they find the nearest roundabout to an Asda or a Tesco supermarket and plant a store there to capture passing shoppers.

But Bryan Roberts, retail insight director at Kantar, argues it is wrong to write off Aldi, one of the world’s largest retail chains with more than 9,000 stores worldwide and an estimated group turnover of €48.6bn (£42.4bn): “Aldi is not losing market share, it is just plateauing. What we are seeing is a return to normality.”

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Like-for-like sales at the grocer accelerated from 1.1% in the first quarter to 2.9% in the 16 weeks to 2 October. On Tuesday Tesco reported growth of 1.3% for the six months to the end of August. “The update confirms Sainsbury’s is now the fastest growing of the four majors,” James Grzinic, retail analyst at Jefferies International, said, while pointing out that the dates of the retailers’ second quarters differed.

Grzinic said that supermarkets’ sales figures were also being boosted by the return of food price inflation. Higher food prices contributed just over one percentage point to Sainsbury’s underlying growth during the period. Sainsbury’s said that the business had performed well across the board with robust trading at its supermarkets bolstered by growth online and at the convenience chain Sainsbury’s Local, where annual sales now top £1bn.

The retailer, which has been aggressively expanding its clothing and homewares ranges, said that non-food sales were growing three times as fast as its grocery division, with childrenswear the star performer. Recent data showed that Sainsbury’s smaller, upmarket rival Waitrose is growing at twice the market rate.

However, King said that Sainsbury’s customer base was not skewed towards the wealthy, emphasising its work on local sourcing, animal welfare and sustainability. During the quarter all Sainsbury’s green salads and cucumbers came from UK farms and it sold 80% of the country’s apricot crop.

King played down reports that Sainsbury’s was gearing up to enter China but said that the retailer had a 100-strong team working in the country, many of whom were involved in sourcing goods. Analysts report that a “supermarket space race” is under way, with Tesco to open 1.7m sq ft (160,000 sq metres) of new retail space in the second half – equivalent to 16% of rival chain Morrisons.

But King said Sainsbury’s had not been outmanoeuvred: “We were there first. We will add 1.5m sq ft of space this year.” Competition regulators are making Asda sell 47 of the stores it is buying from Netto for nearly £800m but King said that Sainsbury’s interest was “de minimis”. The shares closed down 2.5p at 387p.

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“The global economic headwinds of the last two years are being replaced by the tailwinds of recovery in most of our markets,” he said. “Our important Asian markets in particular are emerging strongly from recession.” Leahy added that the UK chain had “coped very well with subdued demand”.

Leahy’s comments came as Tesco reported underlying first-half profits up 14% at £1.8bn. Group sales rose 8% to £32.9bn. UK like-for-like sales for the second quarter were up by just 0.4% (excluding VAT and fuel) which Shore Capital analyst Clive Black said meant trading had been “tough” for the grocer. The figure is “low” by Tesco’s own standards and implied a decrease in sales volumes, once food price inflation was stripped out, he said.

The most recent figures from consumer research firm Kantar Worldpanel showed Tesco’s market share slipping to 30.8% from 30.9%, with growth trailing behind its rivals. Morrisons reported growth of 1% for the period and Sainsbury’s is expected to report growth of 1.3% on Wednesday.

Speaking to reporters, Tesco finance director Laurie McIlwee blamed weak domestic growth on the fact that “the economy is pretty stagnant”, although there were “signs of a recovery”. He said higher food inflation last year made for tough comparatives, while higher fuel costs meant customers had less to spend in stores. Like-for-like growth at its international business was 2%.

Tesco will open 1.7m square feet of new store space in the second half – equivalent to 16% of rival chain Morrisons’ stores – creating 9,000 jobs in the UK. Tesco also signalled its commitment to US startup Fresh & Easy, which was launched in 2007 but is still loss-making. Like-for-like sales at the US chain were up 10% in the six months to 28 August and Tesco said it now expected the business to break even by the end of the 2012/2013 financial year.

Jefferies International analyst James Grzinic said it was a “steady” set of results, adding: “UK sales are lighter than we expected but there is surprising progress on margins.” UK earnings before financial charges were £20m higher than Grzinic expected. In early morning trading the shares were up more than 1% at 435.5p.

McIlwee said Tesco Bank was now a “significant” part of the group’s business, with revenues of £474m in the first half and trading profits up 12.2% to £129m. He said new insurance products and a fixed-rate savings account would be launched in the next few months but confirmed that mortgages would not be launched until 2011 as the retailer is yet to receive the green light from the Financial Services Authority.

Despite the sluggish domestic consumer backdrop, Leahy, who will step down as chief executive in March, said growth in emerging markets would prevent developed economies like the UK and US tumbling back into recession: “My starting point is the global economy which is a pretty robust recovery.

Will this low recovery run out of steam? I don’t think it will. If you look at the consumer psychology and the pulling power of the developing markets, I think they will pull Europe and the United States into a stable and established recovery.”

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“In the first half of 2011 we will begin a trial of a new convenience format and we are currently investigating the opportunities for Morrisons in the internet grocery channel. Morrisons’s past success has been built on being different in the offer we bring to customers, and this will continue in any new areas for business development,” the company told the City.

Since joining Morrisons at the end of March, Philips has been reviewing the business – which enjoyed considerable success under his predecessor. He is planning to create new own-label brands, and launch initiatives to drive Morrisons’s fresh food credentials.

“I am delighted to be leading a great company and, with the whole team, I am determined to make Morrisons better than ever,” Philips said.

Analysts have been eager to hear about a new strategic direction. The supermarket company recently completed a four-year “optimisation” plan to repair its profits following the troubled takeover of Safeway in 2004.

Unlike rivals such as Tesco and Sainsbury’s, Morrisons has not been tempted to offer an online shopping service. Last year, Bolland said the company was “looking into it”, but was keen to avoid the mistakes made by others.

Philips announced his new strategy alongside the group’s interim financial results for the six months to 1 August. Turnover rose 9.1% during the half-year, with the number of customers hitting a new record of 800,000 a week. Like-for-like sales growth slowed, though, to 0.9%, while the amount spent by each customer dropped by 0.2%.

“We expect low market growth to continue in the second half of the year, with further pressure on the consumer,” the supermarket cautioned.

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When Tesco boss Sir Terry Leahy announced last week that he was bowing out after 14 years as the nation’s number one shopkeeper, most attention focused on what he had achieved in turning a downmarket grocer into the world’s third-biggest retailer.

His departure came just weeks after new bosses were installed at rivals Asda and Morrisons. But as the curtain comes down on Leahy’s career, and a new generation of supermarket bosses takes over running the £130bn sector, the food retailing business is facing tough times.

According to one supermarket chief, who declined to be named, a “bloodbath” could be imminent and thousands of jobs could be at risk. Grocers will be cutting their cloth for leaner times as the support provided by rising food prices is whipped away. A price war could also be looming – good news for shoppers, but not for the retailers.

Andy Bond, the former chief executive of Asda who has recently moved into a new role as part-time chairman, doesn’t entirely agree, but says supermarket chains face two issues – the difficult consumer environment and the disappearance of inflation.

“I wouldn’t forecast a bloodbath, but it is going to be the most difficult year for a long time,” he warns. “I think we are heading into an extremely tough period. Shoppers are undoubtedly finding things difficult. Our Asda income tracker is a good indicator. [It recently showed that discretionary income – for spending on extras such as holidays, eating out, sports and toys – in the average UK household is down 4.2% on a year ago.]

Mortgage rates are no longer declining; fuel costs and transport costs are going up. When we get increasing unemployment in the public sector, consumer confidence is going to drop again, particularly outside the home counties, in towns which have a lot of public sector employment.”

Clive Black at Shore Capital agrees that declining confidence could hit profits: “Another dip in consumer behavior and analysts could be getting their red pens out.” And while the recent decline in food inflation is good news for shoppers, it presents real problems for the grocers, which are among the UK’s biggest employers.

Over the past couple of years they have boasted of big increases in like-for-like sales revenues. But even though Office of National Statistics figures were showing the rate of food inflation increasing at up to 13.7%, they insisted the revenue gains were the result of them selling more goods, not just because of rising prices. Justin King, chief executive of Sainsbury, went as far as to suggest the official ONS figures did not pass the “smell test”.

Now, however, with food inflation around zero, the grocers’ sales-revenue growth has ground to a halt. Morrisons recently said like-for-like sales were up just 0.8% – after increases of up to 6% last year – while Asda’s most recent figures showed like-for-like sales in decline for the first time in four years.

“Most like-for-likes are subdued, not much more than zero,” says Bond. “That makes life difficult. People were not honest enough last year about where the growth was coming from.”

Supermarkets have just three ways of increasing their turnover – from higher prices, from selling more goods, or from opening more stores. The key is to keep revenue rising faster than costs, and that is the trick they have to pull off this year when their overheads are suddenly motoring ahead.

The chief executive of another leading grocer says: “If you have zero food inflation and zero volume growth because you do not have enough new stores opening, but at the same time are facing a pay bill increase of 3%, rising distribution and energy costs and upward rent reviews, there is no way of making the numbers add up. Your profit and loss is going to go into reverse. But if any supermarket boss did not work that out a few years ago, they shouldn’t be in their job.

“It wasn’t difficult to see this coming. We were always going to come back off inflation rates of 7-8% and back to more normal rates of 2-3%.” Supermarket chiefs need to be opening new stores, but the planning regime means that is not as simple as it sounds. “You need to be growing your space by 5% a year to hold your own in this market,” says the supermarket boss.

Tesco has proven to be the most adept at planting its flag – a talent which has attracted the scrutiny of the competition watchdog – with shop formats that can slot into any available space. Morrisons and Asda are only just starting to realise, a decade after the market leader, that they can run smaller shops as well as their usual big out-of-town sheds.

Tesco plans to open nearly 250 new stores in the UK by next March, covering 2.7m sq ft. Sainsbury will open 1.4m sq ft this year while Asda, largely thanks to its acquisition of Netto last month, is now on course to open 2m sq ft this year. By contrast, Morrisons’ stated goal is for just 1.5m sq ft in the next three years.

Black reckons Tesco will have opened new UK stores equal in size to the entire Morrisons chain – 12m sq ft – by 2015. Dave McCarthy at broker Evolution says: “The sector is heading for a difficult time. Opening programmes are doubling, like-for-likes are negative and discretionary income is falling. Uncertainty and risk have increased.”

Bond claims Asda is well placed to prosper “because we forecast lower growth and have cut costs”, but he says lower volume growth also make a price war more likely. A rival adds: “If you don’t have new stores, the only way to get volume growth is to ‘buy’ it through discounting, but no one apart from Tesco can afford that. There is no reason for Tesco to ramp up the pressure, but it may choose to do it for tactical reasons – to hurt rivals.”

Bond says Asda will not start a price war, but neither will it watch business walk out the door if a rival does: “We will do whatever is necessary,” he warns.

Tesco

Chief Executive: Sir Terry Leahy, who announced last week that he is to step down next March after 14 years. He will be succeeded by Tesco lifer Phil Clarke, boss of the group’s international business.

Like-for-like sales: Estimated at between 0.5% down and 0.5% up for the three months to the end of May.

UK stores: 2,482 stores covering 33m sq ft.

UK expansion: 246 outlets covering 2.7m sq ft by next March (it will also open 523 stores overseas, covering 8.5m sq ft).

Asda

Chief Executive: Andy Clarke, who used to be chief operating officer and was promoted last month after Andy Bond quit to become part-time chairman.

Like-for-like sales: Down 0.3% in the first quarter.

UK stores: 374 covering 17.2m sq ft.

UK expansion: Asda has just bought the 193-store Netto chain, adding some 1.5m sq ft, and 15 new stores and extensions will add another 0.5m sq ft this year.

International: Asda is owned by Wal-Mart, which has 8,445 stores in 15 markets (including the UK) covering 955.8m sq ft.

Sainsbury

Chief Executive: Justin King, who will become the sector’s elder statesman once Leahy steps down. The former M&S food boss joined in March 2004 when the grocer was a basket case and has set about “Making Sainsbury’s Great Again”, as his improvement programme puts it.

Like-for-like sales: Estimated to be flat in the first quarter.

UK stores: 872 covering 17.7m sq ft.

UK expansion: 1.4m sq ft this year.

Morrisons

Chief Executive: Dalton Philips, who was imported from Canadian grocer Loblaw, and touched down in Bradford two months ago. He will unveil his new strategy in September but is thought to want to give the retailer a more upmarket image.

Like-for-like sales: Up 0.8% in the 13 weeks to 2 May.

UK stores: 425 covering 12m sq ft.

UK expansion: 1.5m sq ft over three years.

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