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There's Always a Reason
Enduring business models in competitive industries exist for good reasons. Dollar stores provide an important option for customers chronically short on cash.
Who Needs a $89 T-Shirt?
The Wall Street Journal publishes a section called Off Duty which covers products and services intended for wealthy consumers, or those who aspire to be seen as wealthy. Along with the Mansion section, I read the articles like funny pages. Whether it is a story about a buyer of a brand new luxury condominium who spent $500,000 to rip out an already luxurious kitchen to install one that’s even more ostentatious or the man who thinks his wardrobe isn’t complete without a $89 t-shirt, it’s all comedy to me!
I can laugh, but businesses catering to the wealthy exist for good reasons. Whether purchases of luxury goods and services are driven by a genuine perception of value for the money, for psychological reasons, or to signal wealth and status, some of the best brands in the world have mastered the art of selling to the top one percent.
In a competitive landscape, all successful business models that endure for a long time exist for a reason. If we cannot figure out the reason, the problem is our lack of skill or insight as business analysts, not that the business model makes no sense.
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Who Pays 16.5% on a Used Car Loan?
I do not understand many business models that cater to the opposite end of the spectrum although, not being a sociopath, I do not find the plight of poor people to be amusing. I might not understand why poor people make the choices they make, but I have enough humility to realize that they are not trying to waste money. For people who live paycheck-to-paycheck, you can bet that most dollars are spent thoughtfully.
When I started researching America’s Car-Mart last year, I could not understand the value proposition of buying older used vehicles with 16.5% financing, but spending some time reading about the situation and giving it careful thought, I concluded that buyers were not necessarily irrational in light of their available alternatives. I recently found myself in a similar situation when I began looking at the dollar store industry. The problem was my lack of understanding, not that the industry makes no sense. By definition, the fact that tens of thousands of these small-box stores actually exist means that the business model is not crazy.
In my article about Dollar General, I wrote about what I gathered from reading the annual report as well as other sources covering the retail landscape. However, I do not live near any Dollar General locations. It is difficult to understand a retailer if you’ve never been in one of the stores. Rather than visiting the nearest location, I decided to wait until I could visit a more rural small-town location. This opportunity came up yesterday as I found myself traveling through Virginia’s scenic Shenandoah Valley.
I picked the small town of Stanley because it is a significant detour from Interstate 81 and has both a Dollar General and a Family Dollar. Stanley is just under fifteen miles from exit 264 at New Market. The town had a population of 1,715 people as of 2021 and is located in a picturesque rural setting with great views of the mountains.
I should make it clear that my purpose for visiting the town was simply to see a Dollar General and a Family Dollar for myself as a shopper buying a few items. I did not conduct organized price checks and, other than taking a photo of the exterior of each building, I did not document the visit with photos. In a small community where most customers are probably recognized on sight, I felt self-conscious about taking notes or photos, plus I had limited time for my brief visit. As such, my description should be taken as an anecdotal account of two stores among tens of thousands across America.
I’m sharing my observations mainly because I suspect that many people reading about dollar stores have not shopped at one, at least not in the rural communities where such stores have the majority of their locations. Perhaps these observations will be useful, although I would recommend a personal visit especially for those considering an investment in this industry.
The map below shows the location of Family Dollar and Dollar General along with a Food Lion grocery store (highlighted in the red rectangle). The nearest Wal-Mart is in Luray, Virginia, approximately 8.5 miles from Stanley and it took me about fifteen minutes to make the trip through a rural countryside dotted with farms.
My first stop was the Family Dollar. This store is a stand-alone small-box location with ample parking and no stores directly adjacent to it. I took a few photos of the exterior of the store but they have cars with license plates visible so I prefer to use this Google street view photo captured in 2018. The surrounding neighborhood is mainly residential and homes can be characterized as modest, with some on small acreage.
When I pulled up to the store, there were only a couple of cars in the lot but it was clear that there were more shoppers in the store who must have walked from their homes nearby. When I walked into the store, I did not see any employees initially and I started browsing the relatively crowded aisles.
Although both Family Dollar and Dollar General have a sales mix of ~80% consumable items, it seemed like far less than 80% of the square footage was allocated to consumables. There were aisles of soft goods such as towels and sheet sets as well as other small household items. Two sides of the store had refrigerated and frozen items while the center aisles had a large variety of snacks, canned, and processed foods. As discussed in my article on Dollar General, non-consumables are higher margin which perhaps accounts for the greater share of shelf space allocated to such goods.
I ended up purchasing two snack size (1.75 ounce) Planter’s peanuts for $0.65 each and a Coke Zero for $2.35 which seems roughly comparable with the prices available at a typical gas station. There were no self-checkouts. The clerk was friendly and efficient. I did not notice any employees in the store other than the checkout clerk. As I walked out of the store, several teenagers walked in, probably looking for after-school snacks.
I drove to the Dollar General which is less than a quarter mile down Main Street. There were considerably more cars in the parking lot and the building looked even more modest than the Family Dollar. The image below is from Google street view which I’m using to avoid posting my photo of cars with license plate information.
Something about this building seemed very low budget to me. Perhaps it was the corrugated metal siding, but it is clearly a no-frills property. The local neighborhood is much the same as near the Family Dollar, with homes in easy walking distance.
There seemed to be more shopping carts and baskets available at the Dollar General but the store was otherwise very similar in terms of layout and selection. I actually found something to purchase for a dollar — a store branded mix of peanuts, almonds, and dry cranberries. This type of trail mix might be a couple of dollars or more at a typical gas station. Surprisingly, the store had a self-checkout which I used and I found it to be a standard system that even supported Apple Pay.
The aisles were quite crowded and I can see how shoplifting could be very easy. The stores are not staffed by many employees and I did not see any sort of security system. Dollar General has indeed suffered increasing levels of “shrinkage” in recent quarters and inventory has been slower to turn over, as discussed in my article.
There were two employees at the front of the store and one customer checking out who was counting out her change for the purchase. I dislike stereotyping, but outward appearances of many customers in both stores indicated some level of poverty. Several vehicles in the parking lot were older and in poorer than average condition.
One of the reasons I picked Stanley, aside from its location far from the interstate and Wal-Mart, was because a reasonably large grocery store is in town. The Food Lion appeared to be a typically sized grocery store, probably in the neighborhood of 30,000 square feet, and it sits on a large parcel of land next to the Dollar General, although it is not visible from Dollar General due to trees on the lot line. I did not go inside this Food Lion, running short of time on my trip, but I have been in other Food Lion locations and it has what one would expect in a typical grocery store.
Using Google street view, I confirmed that the Food Lion existed at its current location before the Dollar General opened. The image taken in 2012 shows that the present Dollar General site was a residential parcel. By 2018, the Dollar General was in place. The Food Lion is visible to the left of the house in the 2012 photo.
The same is true for the Family Dollar. In 2012, the present site was open land. By 2018, the Family Dollar was in place:
So an important question can be answered. We know that the Food Lion existed in Stanley before either dollar store decided to open in brand new buildings in town. I find this quite interesting because it signals a major market opportunity and these companies were not deterred by an incumbent full-line supermarket close by.
The Value Proposition
From my brief “field trip”, I have a working theory for what brings shoppers into dollar stores. I believe that the combination of reasonable prices and small package sizing is probably the secret sauce that allows stores to establish a niche in small communities like Stanley. Full-line supermarkets are going to offer far greater selection than one can find in a dollar store but package sizes are larger. Prices at the supermarket could very well be lower, especially if shopping the weekly “loss leader” sales, but they are lower on a per-ounce or per-pound basis, not in absolute terms.
To understand why the dollar store might have appeal, consider that the typical customer can be thought of as the precise opposite of a Costco shopper. When I go to Costco, I have no problem paying $20 for twelve rolls of paper towels, $12 for two-and-half pounds of coffee, or $10 for three large bottles of mouthwash. My goal is to get the best deal on a per-unit basis and I am not in any way constrained by an ability to part with cash in advance of actually consuming these items.
The dollar store customer is at the other end of the economic spectrum.
Imagine a low-wage earner who is going to be paid on Friday afternoon. It is Wednesday morning and she has run out of a number of items — cereal, bacon, canned soup, dish soap, laundry detergent, mac & cheese, and paper towels.
She has $20 or $30 in cash and that’s all she has until Friday afternoon.
She might go to Food Lion and shop the loss leaders and be able to purchase everything she needs, but it would be a stretch because the product sizes, while not giant, are still too large. But she knows that she can obtain this variety of items from Dollar General or Family Dollar due to small packages and reasonably low prices.
Spending an hour in a small town with brief visits to two stores is hardly an in-depth research project but I found the effort to make the detour useful because I feel like I have a better understanding of the layout of these stores and the positioning of the value proposition in smaller towns. Aside from that, driving through rural, small town America away from the interstate is an enjoyable experience.
Viewed from the perspective of an affluent consumer who faces no constraints at all when it comes to purchasing basic necessities, a dollar store seems like a poor value. Why not just go to Costco? But it doesn’t take much reflection to understand why this premise is simply false. It is also specious to argue that small communities like Stanley would be better off without dollar stores. If that was the case, no one would shop there and two competing stores would not have opened in recent years.
Without dollar stores, low-income shoppers would have the Food Lion but perhaps they would have to decide whether to buy cereal or bacon due to larger package sizes. Maybe it wouldn’t be possible to have both, or maybe laundry day would have to be put off until payday. Or maybe the Exxon station’s minimart will have some items that could suffice. It’s easy to see why these are lousy options compared to the dollar store.
I remain on the sidelines when it comes to investing in Dollar General but I no longer doubt that there is a good reason for the existence of dollar stores and that such stores will continue to exist in the United States for decades to come.
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