Outside the Box
HVRs move from loss-leader gas to everyday low pricing and fuel-loyalty partners.
As news of the closure of 10 Sam’s Club stores hit in January, the owner of a station near a targeted Houston location reacted with delight.
“I hate them,” says Nick—who gives only his first name—citing how Sam’s Club typically had the cheapest gas price in a 3- to 4-mile radius. “They ruin small businesses.”
The closures by no means signal the end of Sam’s, which operates 432 fuel sites and also announced plans to open six more locations in fiscal 2010. But the shuttering does show that even this highvolume retailer (HVR), which a decade ago struck fear into the hearts of c-store operators, has its vulnerabilities. (Many of the HVRs in this article, including Sam’s Club, declined comment.)
After dealing with some of the first HVRs entering fuel almost two decades ago, Bill Kent, president of the 28-store, Midland, Texas-based Kent Cos., knows just what it means to stay competitive. In that period, he’s seen the worst of times move into more of a gray area. While HVRs still employ lowball tactics, Kent says he’s “not found them to be totally irrational.” Indeed, at times, he says, “They’ve appeared to be willing to enjoy some margin.”
And although HVRs remain price leaders when it comes to gasoline, Kent considers himself a tough volume competitor in his own right. “If we have stores on top of them, we are just as aggressive as they are,” he says. When HVRs first entered fuel with prices 10 to 15 cents per gallon below the street, supermarket and mass-merchandising chains such as Sam’s, Walmart, Safeway and Costco posed a real threat to thousands of retailers. Industry frenzy and the emergence of belowcost selling laws were hallmarks of the late 1990s and early 2000s. That dust seems to have settled, at least for now.
Meanwhile, the latest competitive weapon comes in the form of sophisticated loyalty programs, championed by fuel-committed grocers such as Kroger and Giant Eagle. Such programs, many of which partner with established fuel retailers, give 5-centsa- gallon discounts for grocery purchases of $50, with the mathematics allowing the customer, the grocer and even the fuel-retail partner to win.
Speaking specifically of a deal between Cincinnati-based Kroger Co. and Houston-based Shell, Michael Lopez, market research coordinator for Westminster, Colo.-based Energy Analysts International (EAI), says the supermarket giant is extending its “umbrella” of effectiveness, reaching out to Shell jobbers in lieu of making the capital investments in the still-coveted category of gasoline. “We think strongly that this is going to be the hypermarket’s new influence,” Lopez says.
The programs have yet to achieve pervasiveness, but they’re emerging quickly. What exists now, many observers believe, is a middle place where HVRs are employing more of an everyday low pricing, or EDLP, strategy. In more established HVR fuel markets, loss-leader pricing—which has an introductory and temporary bent— has evolved into to a more relaxed, perception- based EDLP. In one case, HVRs are actually giving the gas away; in the other, they only appear to be.
Fortunately for c-store retailers selling fuel, loyalty programs can also level the playing field. Fuel is the “secret sauce,” according to Nicole Walker, vice president of marketing for MetroSplash Systems Group, Dallas, which is a loyalty-solutions provider. Discounts on gasoline have a compelling lure over other incentives, and c-store retailers can take charge by starting their own loyalty programs. By doing so, they can direct the benefits to their own margin and volume goals.
“We’re seeing a big shift in the convenience store offering its own internal program,” she says.
DAWN OF A NEW DAY
So why have things changed? Many point to a defining moment in 2001, when Kroger dropped gas prices 10 cents below market norms in Dayton, Ohio, as part of a grand-opening celebration. A nearby Meijer location cut its price in response.
The ensuing price war led to street prices as low as 10 cents per gallon for a short while, with customers lined up in droves. “It only lasted for a couple of days until [Kroger and Meijer] found that this was ridiculous,” recalls Ed Weglarz, executive vice president of the Farmington Hills, Mich.-based Associated Food & Petroleum Dealers. “Yeah, they were selling gasoline like crazy, but obviously, on every gallon they were losing money.” And he points out that gasoline sales don’t always translate inside the store: “When the place is crowded and people are waiting in line, I think it has actually a negative effect on store sales, because a customer has already waited in line for 20–30 minutes, and now he just wants to get his gas and get the heck out of there.”
PMAA president Dan Gilligan said he thinks the experience was a “learning process,” with the retailers suffering “enormous losses on that fight.” Although HVRs may still tap gasoline as a loss leader to make a “big splash” in a new market, Gilligan says they have “started learning the pain of how much money you could lose selling gas below cost.” And 11 states have implemented “below-cost laws” to ensure those kind of tactics don’t happen.
Fundamental to hypermarkets’ continued strength is their perception of “loss leader,” even when that’s not always the case. It’s the essence of an EDLP strategy. David Strasser, an analyst for Janney Montgomery Scott, Philadelphia, who covers BJ’s, Walmart and Costco, says that while the companies do take a profit on gasoline, a low-cost picture remains.
“The higher the cost of gas prices in general, or oil prices in general, the more favorable people look to the clubs. It drives membership; it drives frequency,” Strasser says. “When gas prices go up, it shows up on the TV who’s the cheapest in town, and it’s usually one of them.” The TV images extend a halo effect, he says: “It just reinforces to the consumer that they have low prices everywhere. If you’re saving money on gas, you’re pretty confident you’re going to save money on cheese.”
But to the benefit of established fuel retailers, HVRs are also realizing that there’s actually not much gasoline margin to play with. In Kroger’s third-quarter 2009 investor conference call, chairman and CEO David Dillon said the company earned an average 11.9 cents per gallon, compared with “exceptionally strong margins” of 23.9 cents in the same quarter of 2008.
“And I can tell you that there’s little, if any, profit on gasoline,” Weglarz says. “When you take the amount of margin and you take out the creditcard- swipe fees, there’s very little left to cover payroll, insurance, utilities, all those other items you would think a merchant has to cover.”
Undercutting HVRs’ price-cutting appeal is a simple fact: People are driving less. High unemployment levels translate to fewer commuters driving to work. Also, today’s fleet of cars, from traditional to hybrid, are more fuel-efficient, thus requiring fewer fill-ups. After years of annual increases, EAI forecasts gasoline consumption to be flat in 2010, with continued declines of 0.5% to 1% per year. And some observers are suggesting fuel consumption could fall by as much as 2% to 3%.
There is another factor: Slumping retail has also translated to a slowdown in warehouse growth. In the case of Sam’s Club, the store closings mark the first time in the company’s 26-year history that it ends a fiscal year with fewer stores than it started with, according to Walmart Today. While Strasser says the warehouse business does continue to expand, he says, “It’s probably seen the best of its growth.”
Lopez of EAI says, “A lot of them are holding back on some of the big builds, just because they’ve got to rein in some of their growth estimates until the economy kind of shakes out.”
EAI reports that hypermarket/fuel/ retail site growth greatly moderated in 2007 through 2009. And Lopez points out that some forays have not come to fruition, such as Vinings, Ga.-based The Home Depot’s growth from its pilot cstore program, Lakeland, Fla.-based Publix Super Markets Inc.’s slowdown and Boise, Idaho-based Albertson’s pulling out of fuel altogether.
“There are some real cracks in the bullish foundation that we might have seen earlier, because some things never came to light,” Lopez says.
FUEL IS KING
Hypermarkets’ infatuation with fuel may be experiencing a turning point as HVRs begin to court fuel partners as a way to grow the category, according to Scott Wetzel, vice president of marketing for Excentus Corp., Irving, Texas, a loyalty-solutions provider with the fuelperks! program.
One national supermarket client he declined to name started to partner with established fuel retailers where they could not build themselves, because of deed restrictions on land and other reasons. Wetzel says, “They saw little dropoff in effectiveness in terms of attracting and keeping customers.”
Another reason to court established fuel retailers, especially when an HVR has limits on building its own facilities, is the compelling nature of fuel as a loyalty incentive. Simply put, gasoline trumps all. Another of Wetzel’s HVR clients pitted the same promotional item against itself, offering it in two forms: a coupon and in fuel rewards. Sales volume for the item rewarded via fuel discounts did 300% better. With that knowledge, the HVR client set about turning most of its temporary price reduction (TPR) strategies, such as coupons or buy-one-getone- free offers, into fuel-based rewards.
Walker says one of MetroSplash’s “very progressive” clients is developing mobile-phone applications wherein fuel is pivotal. In one scenario, a mobile ad would go out to customers for a 2- cent-per-gallon discount on gas for buying a certain fountain drink within the hour. Why is gasoline so important? “If you’re in a car and got a text that said come into [our store] and get a fountain drink for 50 cents, you’re immune to it because you get those kinds of offers all the time,” she says. “With fuel, it’s different. People seek out the opportunity to earn it.”
Loyalty programs help companies make decisions based on measured results, as often shown by their significant investments in new fuel sites and major-oil ties. “Kroger, with its stateof- the-art [loyalty] system, knows down to the penny what a loss-leading gallon does to the inside of the store,” says Al Meyers, senior vice president of Columbus, Ohio-based Kantar Retail (formerly TNS Retail Forward). “My guess is that if they’re adding fuel, they’ve figured that formula out.”
Loyalty programs today are able to track what people buy, what they get along with certain products (also called market basket purchases), the frequency of visits and other helpful data. Over time, such tracking also gives compelling pictures of how consumers respond to promotions. “With a loyalty application, [retailers] are able to slice up their audience according to demographic factors, age, sex, income, frequency of visits,” Meyers says. “And when they run a promotion, they can watch distinct groups to see if it had an impact.”
Typically for HVRs, demographics are all about total amount and frequency of spend, Wetzel says. The game is about how to make the most loyal, highestspending customers buy more and the least loyal, low-frequency customer increase visits. Case in point: Grocers discovered through basket-sales analysis that they were losing customers to big-box retailers on items such as paper towels and canned goods, not on perishables such as fresh meats. Fuel rewards got them back in to buy the non-perishables. “And in turn, they started seeing basket size increase,” Wetzel says.
Eventually, the focus becomes identifying which promotion items people respond to the most. From this analysis, retailers can offer numerous types of rewards, ranging from promotions sponsored by vendors to a flat 5-centsoff- per-gallon for every $50 in groceries purchased. “What we’re finding now is a blend,” Wetzel says, “a basket reward on $50, then offering bonus rewards on specific items that they’ll fund off a [consumer packaged goods] discount or a promotion they fund out-of-pocket.” Fortunately for c-store operators, loyalty programs aren’t exclusive to big box, and in some ways are helping to level the playing field.
“Convenience retailers didn’t just roll over; many of them have now created their own loyalty programs with their own rewards,” Gilligan says. And many prefer to operate the programs on their own, rather than partner with a grocer. Wetzel of Excentus says, “When you’re in control, you can promote high-margin, high-waste items like coffee, you can try to stimulate sales in particular areas of store, you can promote unique brand characteristics.”
In addition, some c-store retailers are discovering the value of their own data, and angling to sell vendors movement and basket information. Walker of MetroSplash says one 40-store client is approaching vendors to fund discounts based on the value of the information they can gather. Convenience retailers may also be catching a break in that the grocery-fuel loyalty programs may be limited to the supermarket channel. Based on discussions with retailers who work with big boxes and empirical (though nonscien- tific) site visits, the relationship between fuel and in-store purchasing behavior at mass merchants such as Walmart and Costco doesn’t go beyond EDLP. A few retailers, who spoke on condition of anonymity, say many of the big boxes focus on price, encouraging foodservice and fuel partners to offer discounts or promotional deals, but don’t link the rewards back to how much people spend inside the larger store.
MAJOR OIL MOVES
Undoubtedly, big players are moving into loyalty specifically to take advantage of the grocery-fuel relationship. Major oil companies have sent request for proposals to loyalty providers, actively seeking deals similar to Kroger-Shell and BP-Excentus.
Speaking to the announcement last November, Wetzel says BP signed on to be the national redemption site for Excentus’ fuelperks! program. BP’s philosophy is to partner with others, he says; to that end, the company is enabling its jobbers, dealers and retailers to easily and inexpensively opt into the loyalty program. But it won’t stop with groceries or gasoline. Wetzel says coalition-type relationships with other, noncompeting businesses are forming, with Excentus even developing an online mall.
For retailers, the future may be one of competing with loyalty-discount pricing. “We don’t try to chase that piece of it,” says Kent of Kent Cos., who says he focuses only on his competition’s street posting vs. the additional rollback on groceries purchased. “It probably drives a lot of business for [HVRs], particularly when it’s part of the grocery stores and part of Wal-Mart. It must be a volume driver. We don’t know how to compete against that.”
And while Kent says that competing grocery discounts haven’t hurt his volume so far, he knows it’s something to watch: “Someday that may change; we may have to change our philosophy. … We have to protect our customer base and do what we can.”
HOW TO COMPETE
So going into the future, how do c-stores keep that base?
According to David Portalatin of Port Washington, N.Y.-based customer researcher The NPD Group Inc., c-stores have a few of ways of competing. “There are others going to market in the convenience channel with a private brand, for example, on the low-price offering,” he says. He also points out that price is not the only differentiator in gasoline: “Consumers may be motivated to purchase a product that they feel is going to be better quality, and that quality can be defined a number of ways. Maybe it’s performance in their engine, or cleaning power, or better for air quality, or it could be a lot of dimensions to that.”
Differentiation can also be achieved through customer experience, foodservice and other retail offerings. “So it’s not as if these guys are just a gargantuan steam roller, that because their low price squashes out everybody else in the market,” he says. “I think that [HVRs] appeal to specifically low-price consumers, which leaves room for a lot of other value propositions in the marketplace as well.”
Weglarz points out that a convenient location and good lighting can go a long way toward making a customer feel safe. Little touches, such as having gloves that customers can wear while pumping gasoline or stocked windshield service equipment, also help. “And many times there’s still a segment of the customers that wants to know the owner or the manager,” he says, “and that is totally lost when you go the big-box stores.”
All in all, the industry has the wherewithal to endure. Emily LeRoy, executive director of the Tennessee Fuel and Convenience Store Association, Nashville, Tenn., says that c-stores are used to new, untraditional competitors coming into the marketplace, and are “exceptionally good at rolling with the marketplace, of seeing what the consumer in that particular market wants, and delivering it.”
Innovative retailers can focus on getting fueling customers into the store. “The industry is woefully behind in encouraging [customers to go from the pump to the store]. Where are the big [high-definition] screens? The pizza smells?” says Meyers of Kantar Retail. “There’s a lot that could be done while I’m standing there pumping fuel, so why aren’t we marketing it to death?”
Total Nontraditional U.S. Fuels Market Share
Costco 3.8 %
Sam’s Club 2.2%