Will Dollar Stores Rule the Retail World?

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Rick Wilking / REUTERS

Shoppers enter a Dollar Tree store in Arvada, Colorado on Feb. 25, 2009.

Last Monday, Dollar General, the U.S.’s largest dollar-store chain, posted better-than-expected profits, helping boost the company’s stock, which is up 15% year to date. And earlier this year, it announced plans to open its 11,000th store by the end of the 2013 — an impressive figure for a discount retailer. The only other companies to boast store counts that high are fast-food chains like McDonald’s and Subway.

And Dollar General isn’t the only dollar chain to have had success in recent years. Competitors Dollar Tree and Family Dollar have also experienced significant growth in revenue since the 2008 recession, when many consumers began shopping at discount chains for everyday items like cleaning supplies, toiletries and groceries. Another boon to these sorts of discount chains has been government safety-net programs like food stamps, which prevented those already shopping at dollar stores from being shut out altogether from being able to afford necessities. According to Morningstar analyst Michael Keara, 40% of dollar-store-sector customers rely on some form of government assistance.

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Meanwhile, Walmart — America’s biggest and most successful discount retailer — has not been performing as well since the recession, and is off to a slow start in 2013. So why have dollar stores been able to capitalize on the weak economy while Walmart hasn’t? There are a few reasons:

  1. Walmart was already starting from a position of dominance. When you’re the biggest retailer in the U.S., it’s much more difficult to achieve steady sales growth than if you’re an outfit like Dollar General, which was losing money as recently as 2007.
  2. Dollar stores had the inside track in the race for urban shoppers. Walmart’s bread and butter are rural and ex-urban shoppers who can access its massive supercenters with relative ease. Penetrating the urban market has proved more difficult for the simple reason that the supercenter model cannot easily be reproduced in places with less space. Walmart is trying to remedy this with its push to open more smaller “neighborhood centers,” but it has some catching up to do in order to reach the sort of urban penetration that dollar stores have.
  3. Dollar stores are getting away with higher prices. Though dollar stores are known to sell off-brand items at low prices, overall dollar stores are selling their merchandise at higher margins than Walmart. That means that either dollar stores are buying their goods for less than Walmart, or that dollar stores are getting away with higher prices on a pound-for-pound basis. And given Walmart’s legendary purchasing power and supply-chain management, it’s highly unlikely that any of the major dollar-stores chains can consistently source their merchandise more cheaply. What’s more likely is that dollar stores have successfully masked their higher prices by selling items in smaller portions and by strategically discounting certain items.

With these factors in mind, it’s difficult to see dollar stores maintaining their current growth rates for much longer. Walmart recently announced a plan to ramp up its efforts to build smaller Neighborhood Market outlets, which will be on average about one-third the size of its traditional supercenters. These stores will be better positioned to attract customers in urban centers where Walmart has lagged the competition. The retail giant has also said it will be instituting $6 billion in price cuts over the next several years, which will make it more difficult for dollar chains to maintain their market share and high margins at the same time.

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Walmart has also made several unforced errors in the past couple of years, from limiting its product selection to allegedly understaffing many of its supercenters. But it’s hard to imagine that a company with Walmart’s track record will continue to flounder for very long. Dollar stores have exposed and capitalized on some chinks in Walmart’s armor over the past few years, but the world’s biggest retailer has begun to address those weaknesses, and will no longer be taking the fight lying down.