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Dollar Tree Bears Loot

Find it challenging to offer customers a desirable product line while balancing profit margins and price points? Try operating a dollar store. If the price of chocolate goes up, there's no adding a nickel to the retail. There's no experimenting with higher-retail products to boost the average ticket.

But despite the challenge of working in the fast-growing segment, with an advertising budget well below the industry norm, the folks at Dollar Tree Stores Inc. are finding the $1 business model makes cents. With nearly 2,800 locations operating as Dollar Tree, Dollar Bill$, Dollar Express, Only One Dollar and Only $One, supported by nine distribution centers, Dollar Tree is today's incarnation of the five-and-dime, offering a variety of products, some of which could be found in a 7-Eleven — or a CVS, Target, Party City or Old Navy store.

"People like choice," said Barb Seman, vice president, marketing, for the Chesapeake, Va.-based chain, which offers approximately 2,000 SKUs in each store in a footprint averaging 10,000 square feet. "That's why they'll shop at Wal-Mart and Target and Dollar Tree and other stores. They don't want to be restricted. It's a matter of convenience."

The 19-year-old chain of dollar stores, the nation's largest, is hawking everything from candy to gift bags to flip-flops, always for a buck (or two for $1, or three for $1), unlike many other "dollar" stores, where some merchandise sells at other, often higher, price points. Dollar Tree's core offer consists of seasonal merchandise, such as summer toys, back-to-school items or Christmas decorations; party supplies and gift wrap; health and beauty care items; and a convenience assortment of snacks.

Indeed, about 41 percent of its sales are consumables, according to Hoover's Inc., a business information company. Nine percent of sales are seasonal, with the rest falling in the "variety" category. About 40 percent of the chain's merchandise is imported, primarily from China. But unlike some of its competitors' mixes, closeouts represent less than 10 percent of its inventory. Along with core products, the chain's buyers are on constant lookout for opportunity buys, such as one-gallon buckets of frozen margarita mix, a recent strong seller.

"When it come to maintaining margins, our business model is very similar to other retailers' — we always have to find ways to take costs out and offer a value," Seman said. "We are constantly reviewing our processes, working with vendors, thinking of better ways to get products to the stores more efficiently, getting the right quantity. We're no different than other retailers — we just know at the end of the day what our retail price will be."

The chain's gross profit margin was 33.9 percent in its first quarter, compared to a discount/variety stores' average of less than 25 percent and convenience stores' average of 28.7 percent. Its pre-tax profit margin is 9.22 percent, compared to the dollar store industry's average of 5.53 percent. Dollar Tree's net profit margin is 5.77 percent vs. the industry's 3.8 percent. (For more financial information, see "Dollar Tree's Recent Harvest," Page 58.)

When negotiating with vendors, Seman said, the chain's buying team must often remind them retail prices must be $1. Even so, supplier partnerships have continued to develop. "Twenty years ago, many major product manufacturers didn't consider the dollar sector, but they are now," she noted. "They've taken notice and are now offering programs specifically for the segment."

The growing dollar channel is making a mark, with 17,000 stores, up from 11,000 in 2000, according to ACNielsen. Some 67 percent of households shop at these stores, compared to the 45 percent of households shopping at c-stores.

"The sector as a whole has pretty strong long-term growth prospects, particularly as companies increase their assortment of food and other consumable products," according to Mark Miller, an analyst with William Blair & Co. LLC, which rates Dollar Tree's stock as an underperformer.

"As Wal-Mart expands with Supercenters, which represent the bulk of their square-footage growth, more food is going through these very large 180,000-square-foot stores," Miller said. "The smaller-store convenience of the dollar stores is probably rising in its importance to the consumer."

Dollar Tree is maximizing that opportunity. The chain added approximately 250 stores last year and expects to add 225 in fiscal 2005, as well as relocate or expand a somewhat smaller number of locations.

"There is plenty of room to grow and we still believe we could double store count in the country," president and CEO Bob Sasser told the investment community in late May. "How fast we get there is dependent on how confident we are of the climate to grow in and the ability to grow profitability. I'm not looking to ratchet [up store growth] next year, but keep it in the 14 to 16 percent range."

Despite the desire to grow, Dollar Tree isn't likely to succumb to bidding wars for expensive corner sites. The chain often anchors strip malls, moving into older locations and refurbishing them to create a consistent Dollar Tree identity, but not investing in a great deal more.

"If you are a retailer with something to offer, people will come to you," Seman said. "We are looking to serve our customers — lower- to middle-income customers are our target — and there are many pockets in rural, urban and suburban settings. Often, we are giving new life to some older centers."

Today, Dollar Tree's ideal building would be 12,500 square feet. "The stores we were opening five years ago aren't relevant today," Sasser said. "They were 3,000 to 5,000 square feet next to a Target or Wal-Mart. They became non-competitive and couldn't hold the [current] merchandise mix. As a group they are our worst performers.

"As we've grown to better serve our customers, we've grown the store size [and offer.] Of the large stores that we have, the 12,500 square foot is the most productive in terms of sales per square foot. It gives us the ability to show the customer all of our merchandise and be competitive and it costs a little less than the 15,000 and 16,000s."

To keep customers returning, Dollar Tree's store managers and associates are empowered to determine much of what ends up on the shelf, with guidance and recommendations from the home office.

"If a store sells out of something in three days, the manager has to be creative and determine what makes sense in that store and what will go up on the shelf next, because we are a bit of a neighborhood store," Seman said.

While approximately 60 stores now offer refrigerated and/or frozen products, the chain is experimenting more with those categories. "Are they profitable for us? Do they meet our customers' needs? We are approaching it very carefully," Seman said.

This is one chain, the convenience industry will be happy to learn, that is not looking to sell motor fuels. "Sell gasoline?" Seaman chuckled. "What customer in the world wouldn't want to buy a gallon for $1? But no."

The completion of a point-of-sale scanning initiative at the end of 2004 is likely to have a big impact on the mix, Seman added. "I'm sure we'll all get smarter and be surprised at the things we thought were selling, but find out, 'Oh, guess what. It's not selling that well.' Customers in different communities will be better served."

Dollar Tree's typical customer — "if there is one," Seman said — is a person, likely a woman, who has been to the store for some reason in the past and wants to see what is new. "Dollar Tree may not be on her 'must go to' list, like the grocery store would be, but she keeps coming back because she wants to know what we have now that we didn't have the last time she was in the store," Seman said.

"But consumers only have so much to spend — and getting [our share] is a challenge we face, like other retailers do. Opening more stores closer to customers' homes or where they work will help us."

More advertising may help too. The company is planning to increase its advertising budget this year, with most of its investment going to radio and television advertising that introduces Dollar Tree and reinforces the "Absolutely everything is $1, unlike some other dollar stores" message. Another big chunk of the promotional budget is spent on store grand openings. With everything priced at $1, there is no need for coupons, limited-time promotions, discounts, seasonal sales or other promotional activity. It's a nice way to keep expenses down.

"One customer in a focus group said, 'This is a no-brainer. I don't have to worry about forgetting my coupon or wondering if something is on sale this week,'" Seman noted. "They are able to comparison shop in their minds before they come to Dollar Tree. That's a nice advantage for us right now."

Still, value-minded consumers expect quality, too, Seman said. "They may think, 'This only costs a buck, I'll try it.' But if it is not up to the standard they expect, they'll never buy it again, and we don't want that. Customers give us feedback very quickly. If there is an issue with a product, we pull it from the shelves."

To ensure only quality items end up on display, Seman said the company tests most of its products before they hit the shelf, whether they are popular brand names or not-so-well-known brands that "people are happy with." Dollar Tree also develops some of its own products — such as its current line of luau-themed summer dinnerware and color-coordinated flip-flops, tote bags and bucket hats.

"What is important is offering our customers a value and keeping them coming back. The price point is what is unique," Seman said. "The customers who shop us regularly do feel there is a difference — that being everything in the store is $1." n
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