Forget Wal-Mart. What's your dollar store strategy?

Aug. 12, 2004
Collectively, they're growing bigger and faster than any other outlet. But food marketers need to carefully consider repackaging costs and the brand image of being in a discount store
They have more stores and faster growth than Wal-Mart -- with eight times as many outlets and a growing appetite for packaged food products. But the dollar-store retail channel remains little understood and even less courted by the food industry.

While dollar stores may not be a major channel for many food companies for years, and may never be a good fit for some brands, they're a growing force for the industry to reckon with, say industry consultants and executives familiar with dollar chains.

"The potential opportunity for food manufacturers is huge," says Ken Harris, partner with the consulting firm Cannondale Associates, Evanston, Ill. "The interest dollar stores have been expressing [in food] mainly has been only in the past year and a half. And those manufacturers who are quick enough to move have benefited a great deal."

Little stores, big punch

While food marketers who haven't delved deeply into dollar stores may be missing the boat, they haven't missed much of the journey yet. Though more than 800 companies operate 25,000 dollar stores, they've concentrated mainly on apparel and household and personal care products, with relatively little space devoted to food , up to now.

That's changing fast. Dollar General, the biggest player in the business, with 6,700 stores and $6 billion in sales, opened its first Dollar General Market in Hendersonville, Tenn., last year. The market combines the traditional 10,000-sq.-ft. discount store with another 7,000 square feet of fresh, refrigerated and frozen foods. Many of Dollar General's existing 6,700 stores have been or are being outfitted with refrigerated and frozen cases to supplement their lineups. And Dollar General's closest competitor, Family Dollar, with 5,100 stores and $4 billion in sales, is watching closely with similar plans rumored.

Household penetration for dollar stores has climbed from 55 to 66 percent in the past four years. Households that shop dollar stores are shopping them more often, too, with the average number of annual shopping trips rising from 10 to 13 over the same period, according ACNielsen.

The selection in dollar stores is a mixture of private label/store brands, second- and third-tier brands, merchandise no longer actively marketed by its manufacturer and special sizes to meet a certain price point. Increasingly, however, there are products that can be found on any grocery store shelf.

While the roots of dollar stores are deep in low-income neighborhoods, current growth is coming predominantly from middle-income consumers. Among households with incomes greater than $70,000, penetration for the channel grew four percentage points last year to 49 percent, according to ACNielsen. Trips per year by that income bracket grew by one to eight, making it the fastest-growing income bracket for dollar stores in both statistics. By comparison, dollar store penetration of households with incomes under $20,000 grew 3 percentage points to 77 percent, with average annual trips remaining steady at 18.

Dollar stores accounted for only 5.1 percent of candy sales and 1.3 percent of snacks and pet food sales last year, according to ACNielsen. But they were also by far the fastest-growing retail channel for each of those food categories, growing share by 8 percent in candy and 30 percent in pet food in one year alone.

A wide-scale rollout of supermarket-hybrid style stores by Dollar General or Family Dollar would dramatically increase the channel's impact on the food industry, said Christopher Hoyt, principal of the Scottsdale, Ariz., consulting firm Hoyt & Co.

While they're fierce competitors, dollar stores may have something of a symbiotic relationship with Wal-Mart, said Todd Hale, senior vice president of consumer insights with ACNielsen. In a county-by-county analysis, household penetration for dollar stores correlates strongly with penetration by Wal-Mart Supercenters, he said.

Dollar stores are swooping in to meet the fill-in convenience shopping needs of supercenter shoppers -- as each new Wal-Mart Supercenter puts an average of two supermarkets out of business. Shopping the compact dollar store is a lot quicker than trekking through a supercenter. "We're benefiting from the black hole that's being created," said David Perdue, chairman and chief executive officer of Dollar General, during a meeting of the International Mass Retail Association last year.

"The huge potential win is that dollar stores are actively looking for help developing their food business," said Harris. "And there will be manufacturers out there smart enough to figure out a way to deal with them and will grow their business that way."

Understanding the landscape

Success with dollar stores means understanding the different operators, says David Bishop, director of Willard Bishop Consulting, Barrington, Ill.

About a third of the segment is made up of over-run or close-out retailers, such as Big Lots, which tend to deal in discontinued or surplus merchandise , retailers that almost no food company intentionally wants to supply.

Another 19 percent is made up of single-price operators, such as Dollar Tree Stores and 99 Cent Only Stores. They tend to operate at a single price point of $1 or less, have a "treasure hunt" appeal and concentrate more on impulse purchases, including snacks and candy. They've also tended to make heavy use of private label.

"Dollar stores are actively looking for help developing their food business, and there will be manufacturers out there smart enough to figure out a way to deal with the them," says Ken Harris of Cannondale Associates.

Although 99 Cent Only Stores has experimented with gourmet produce and other perishables, and SuperValu's "Deals" chain is co-locating with Save-A-Lot limited-assortment supermarkets, this segment still offers "fairly limited" opportunity for most packaged food brands, Bishop says.

The third and biggest segment, and also the one offering the most potential for most packaged-food marketers, is the "extreme value" channel led by Dollar General and Family Dollar, Bishop says. They tend to stock more national brands and consumables, offer even but multiple price points (e.g., $1 to $9) and appear most likely to evolve into supermarket-like hybrid formats.

As these "extreme value" dollar stores, whose prices tend to be competitive with Wal-Mart's, evolve toward more food offerings, they may start to look more like German-based "hard discounter" Aldi and its U.S.-based cousin, Trader Joe's, Bishop says. Aldi, Trader Joe's and SuperValu's Save-A-Lot feature limited assortments, low prices and often rapidly changing brand and product mixes.

Hard choices, new strategies

While dollar stores offer high growth potential, they also present some tough strategic choices for food companies.

"You have to ask: Do you have the product portfolio to have an offering in dollar?" Harris says, noting that high-volume consumables that can be priced competitively are key to getting onto the shelf.

Dealing with dollar stores often means creating special labels to highlight the price and sometimes means reconfiguring package sizes or even formulations to hit the desired price points, Harris says. "Are you willing to make the package/product/marketing investment to make a go of it? If you do it half-heartedly, you probably won't succeed."

A self-examination question is whether "you can reconcile the dollar-store offering with your brand image if you're a premium brand." Harris says. Not all brands will be right for dollar stores, which are limited-assortment formats with a laser-like focus on price.


How do dollar stores compare with grocers?

Another big question: If you do a deal with dollar stores, how does it stack up to your deal with Wal-Mart? Pleasing big, fast-growing Wal-Mart, as its supercenters continue to take share from supermarkets, is what keeps many food executives up at night. But dollar stores are what keep some Wal-Mart executives up at night.

"Wal-Mart is hypersensitive to the dollar channel," Harris says. "So if you offer something to the dollar channel, do it with the full recognition that Wal-Mart is going to find out about what you did and ask what you are going to do for them."

Just as food manufacturers developed massive club-store packs in the 1980s and were forced to offer them to supermarket retailers on comparable terms, they'll face the need to do the same with miniaturized dollar-store packs with Wal-Mart and others.

The tradeoff of growth opportunities offered by dollar stores may be accepting lower margins across multiple channels, Bishop warns. Dollar store buyers make no bones about what they want , the lowest prices for their consumers at the best margins for themselves. Through a combination of bare-knuckle bargaining with suppliers and ruthless efficiency throughout their supply chain, dollar stores have been able to achieve better margins than supermarkets or Wal-Mart.

But some household and personal care products manufacturers who already have dealt with dollar stores for years have found them to be major, profitable accounts. Executives of Clorox Co., maker of Clorox bleach as well as Hidden Valley Ranch dressing and KC Masterpiece barbecue sauce, have said the company now gets about 10 percent of its sales from dollar stores.

Procter & Gamble Co. has made dollar stores a central element of its effort to expand sales to low-income consumers in recent years and now gets from the channel about $1 billion in sales , representing more than 4% of its U.S. business. P&G launched a non-ultra-concentrated version of its Dawn dishwashing detergent to hit a $1 price point and a 20 percent smaller, 80-oz. version of its Tide detergent to hit a $5 price point in dollar stores.

P&G recognized the potential of dollar stores five years ago, when the company had a 13-person team working on developing business in the channel. This was long before most of its competitors were paying much attention to the medium, says Gordon Wade, president of the consulting firm Cincinnati Strategies in Cincinnati and an ex-P&G executive who helped Dollar General plan its expansion into packaged goods categories in the mid-1990s.

"Dollar channels are important because of their growth and rapid expansion, and because they enable us to reach shoppers who prefer these stores," says Stefani Valkonen, a spokeswoman for P&G. She wouldn't confirm the size of P&G's team working on the channel or the sales figures. "We collaborate [with dollar stores] to better understand their target shoppers so there is a more effective variety of options to meet their needs, including sizes and price points."

Household penetration for dollar stores has climbed from 55 percent to 66 percent in the past four years.

But as Wal-Mart becomes increasingly aware of the threat posed by dollar stores, it's also increasingly demanding products originally developed for dollar stores. Earlier this year, the giant retailer added the non-concentrated version of Dawn dishwashing detergent P&G originally developed for dollar stores. It also scrapped its private label detergent program, opting instead to have its private label supplier, Huish Detergents, Salt Lake City, sell Wal-Mart the 100-oz. version of its liquid detergent Sun. Going head-to-head with dollar stores, Wal-Mart began selling the product for $1.90, 10 cents below the $2 Sun retails for at dollar stores.

Bishop expects similar scenarios to play out across food categories. Despite the likelihood that Wal-Mart will want food companies to match any product or program that works effectively in dollar stores, he believes it's important to try to develop business in the channel.

One reason is that since dollar stores have limited assortments, developing a relationship with them can mean eliminating or diminishing the threat of competition within the channel. "Dole Foods in perishables has a virtual lock on all the items in the produce department," Bishop says. "Pepsico's Pepsi and Frito-Lay divisions have been very aggressive at getting front-end merchandising at Dollar General, where you really don't see Coca-Cola products."

While big national players would appear to have an edge, some regional players also find a place in dollar stores. "They're a growing presence in our market areas and we have introduced some sizes that are more suited to dollar stores and reflect the space provided," says Daryl Thomas, chief marketing officer of regional snack marketer Herr's Foods Inc., Philadelphia. "They're certainly not going to have a traditional-sized snack foods section, so you have to look at their needs and adapt your product line. But they do realize there are regional preferences, and when they open a new store, they want to fit in and connect with that market."

In some cases, older national brands that have relatively little presence in the supermarkets and supercenters are finding a new lease on life in the dollar channel. Dollar stores, particularly Dollar General, have proven to be a strong channel for National Beverage Co.'s Faygo and Shasta brands, says Stan Sheridan, president of the Faygo unit. He says the combination of a recognized brand name and a competitive price have been keys for his business in the channel.

In many categories, dollar stores may offer only one of the major national brands alongside a smaller national value brand, regional player and/or private label , making the decisions based on who can give them the best deal or service, Bishop says.

"I think dollar stores believe consumers are less brand sensitive. So [for items] such as pickles and non-dairy creamers, they may only carry the Clover Valley line," he says. "Even though they carry the national brand of Pepsi, they also are carrying the Clover Valley [private label] line of soda products as a flanker."

Food vital to channel growth

While the dollar channel is getting more important to the food and beverage industry, the industry is becoming more important to the dollar channel, too, Wade says. What motivated Dollar General's move into household and personal care products about 10 years ago was the need to bring customers through the door more often for products they needed regularly , something the chain's original mix of apparel and hard goods wasn't accomplishing.

The strategy succeeded in kindling the growth of dollar stores, Wade says, and is in turn leading Dollar General in particular to now look at adding more perishable items, such as milk, cold cuts and produce, to further increase shopping trips.

Expansion into food also is helping dollar stores generate a bigger ring per customer, Bishop says, and making them a more formidable competitor for Wal-Mart supercenters.

"With the expansion into food, what the dollar store offers is price and convenience," he says. "Wal-Mart offers price, but it's hard to have convenience in a 200,000-square-foot store. People shop dollar stores because they have certain needs in mind during that trip, and that's what they're going to fill. Dollar stores don't generally have large transaction sizes. Prior to [adding large food sections], the average transaction size was $9.50. Now, with the market concept, they've been able to essentially double it."

An aging population plays into dollar stores' strengths, adds Wade. Retirees on fixed incomes will be value-conscious, but they won't necessarily want to trudge through massive supercenters to get the best deals. "With a dollar store, you pull into the parking lot and you're about 20 feet away, in a lot of cases," he says. With a supercenter, shoppers need to walk five times more just to get to the front door."

"People who are going to dollar stores will continue to go to dollar stores," Bishop sums. "As dollar stores expand what they offer, [those same] people will buy more of their products there, and the stores will begin to take business away from supermarkets and supercenters."

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