In 1996, a single H. E. Butt (H-E-B) grocery store began selling fuel in its parking lot in Midland, Texas, a mid-size market with a poulation of 300,000 that was well-served by traditional petroleum marketers such as Kent Oil Inc.

"When H-E-B came in we got knocked around on price for about a year. Then it evened out and we thought, 'This isn't too bad,'" said Bill Kent, president and second-generation heir to the company, which was founded more than 40 years ago and currently operates two-dozen retail units.

Since H-E-B's entry into the gasoline market, Kent has watched in dismay as one high-volume retailer (HVR) after another has began selling gasoline as an added-value attraction for their customers.

"H-E-B, two Wal-Marts, a Sam's, an Albertson's, a Lowe's -- and three of those came in within the last year," Kent said, ticking off the latest predators to knife into his turf. "It's as if an entire new industry has come into our market. We've had to battle for our share at every step of the process, but now that we've got six, seven, eight players in our market, our slice of the pie keeps getting smaller and smaller. We've lost about 50 percent of our margin over the last five years. The only way to get it back is by pricing, but we feel a little like an ant trying not to get squashed while the elephants are fighting."

For Kent and his colleagues across the United States, HVRs' enchantment with gasoline has ripped through traditional gasoline markets like a roaring tornado, wreaking irreparable damage to margins and putting scores of petroleum marketers out of business.

And more fallout is expected. HVRs' market share of retail fuel is anticipated to climb from 3 percent to more than 15 percent by 2005, as a growing throng of deep-pocketed supermarkets, warehouse clubs and mass merchants increases their gas presence, according to Energy Analysts International Inc. (EAI). The Westminster, Colo., research group issued a report last December entitled "U.S. Hypermart Petroleum Market Study 2000."

To the consternation of traditional retailers, HVRs are hastening their expansion into this once safe market, reported Fuel Census 2001, a supplement produced earlier this year by Convenience Store News that examines HVRs' rapid ascent in the fuel sector. The following are just a few examples among the more than 30 nontraditional retailers currently selling or expected to sell gas.

Costco Warehouse Corp. of Issaquah, Wash., has opened more than 100 units since 1995, with 40 new gas stations planned for 2001.

Bentonville, Ark.-based Wal-Mart Stores Inc., through alliances with three major refiners/marketers, expects to top 1,000 fueling facilities by 2005.

Troy, Mich.-based Kmart Corp. has rolled out Big K Express c-stores at Kmart centers in Ohio, Virginia and Michigan.

Boise, Idaho-based Albertson's Inc. eclipsed 100 fueling stations just last year.

Concurrent to the surge in high-volume gasoline players, the total gallons of gasoline sold at c-stores dropped in 2000 for the first time in 15 years -- by 1.6 percent, or 1.9 billion gallons, according to the CSNews 2001 Industry Report.

How will petroleum marketers remain viable? How are different channels responding to the encroachment of mega-marketers?

While answers are far from certain, one thing is clear -- the playing field has never been so muddied. "A marketer used to know who his competitor was and could easily evaluate the competition with a few phone calls and a small bit of research," said Dan Gilligan, president of the Petroleum Marketers Association of America. "Today, the competition could be a global retailing enterprise mostly immune to local business conditions. It could be a hypermarketing-holding company operating on the 10th floor of an office building 1,800 miles away. Who is this competitor and will it compete by the rules?"

Legal Fights
To put the issue in perspective, let's go back to 1997 when a number of retailers such as Albertson's, Wal-Mart, Costco, H-E-B and Kroger started testing gasoline sales in their parking lots. The mass merchandisers and grocery chains, with huge economies of scale, could easily exchange razor-thin profit margins on gasoline for high volume, passing the savings on to consumers -- a luxury traditional petroleum marketers historically have lacked.

Hypermarketers also favored less expensive unbranded fuel. For them, gasoline was just another commodity like bread or milk, a promotional tool to increase patronage.

Some of these new competitors attempted to sell gas at or below cost, using it as a loss leader to draw customers to their stores. In response to what many considered
"predatory" pricing, a number of local and national trade organizations representing dealers and fuel marketers have wrestled for legislation and enforcement in some states to prohibit such activities and make it harder for HVRs to undersell small retailers.

In the past two years, for example, marketers have filed challenges in Alabama, Tennessee and Florida accusing, most notably, Wal-Mart and its petroleum partner, Murphy Oil Corp., of underselling the market.

In a win-some, lose-some landscape, some petroleum operators and c-store retailers celebrated a critical victory in Alabama last spring, when two Huntsville-based jobbers, Thrasher Oil Co. and Campbell Sons Oil Co., successfully sued El Dorado, Ark.-based Murphy Oil Co. of violating the state's Motor Fuel Marketing Act.

Bart Fletcher, executive vice president of Montgomery-based Alabama Oilmen's Association/Alabama Association of Convenience Stores, took note of the victory's weight. "It's critical that the law is in place if smaller companies are going to compete against hypermarkets."

In Maryland, legislators overwhelmingly approved a measure strongly endorsed by gasoline dealers that requires the state comptroller to investigate all complaints concerning below-cost selling and determine within three business days whether there is a violation, thus expediting complaints that can linger for one to two years in the court system.

A scan across the country shows that fuel marketers have fared well in either winning tougher below-cost legislation or preserving existing statutes on the book. In addition to Alabama and Maryland, traditional gasoline operators won battles in Minnesota, Florida, Lousiana, Tennessee, Washington and Wisconsin, prompting Jay Allen, Wal-Mart's vice president of corporate affairs, to concede to The Wall Street Journal, "The mistake we made is that we didn't start developing relationships a long time ago."

A good example of Wal-Mart's lack of political clout in the gasoline arena occurred in Florida. Financially well-muscled, the world's largest retailer tag-teamed with Murphy Oil to slam dunk the state's tough below-cost pricing (BCP) statute, known as the Motor Fuel Marketing Practices Act. Yet, despite the support of the state's attorney general, Wal-Mart failed to woo enough lawmakers to overturn the act.

Interestingly, the debate took on an unusual posture. It was the multi-billion dollar Wal-Mart that portrayed itself as a friendly defender of the consumer and free-market system, only to be stifled by control-minded competitors. Traditional gasoline operators countered with grassroots appeal, local philanthropy and political acuity.

New Commodity
While legislative debates will no doubt roar over the next several years, a reality is emerging over this murky retailing landscape -- the Wal-Marts, Costcos and Albertsons are on a fuel feeding frenzy. And they're not about to stop.

These multibillion-dollar companies defend their pricing strategies, asserting they simply price fuel similar to other items, using low prices to push high volumes and build customer loyalty. They also make no secret about their plans to use gasoline as the next step in becoming a one-stop shopping destination for consumers. From a bird's-eye view, the numbers justify the expansion. According to HAC Enterprises, which specializes in helping retailers integrate gasoline into their business, the return on investment for gas sales is an astounding 35 to 65 percent. The investment required to add gas operations, including canopies and dispensers, is $400,000 to $500,000.

The trend is likely to accelerate in the coming years, especially in areas where real estate is available. "The high returns will attract capital because money will always go where it's treated best," said Fadel Gheit, senior energy analyst with Fahnestock and Co. in New York. "If the returns continue to improve we're likely to see more non-traditional investors moving into the business. But it will only last as long as the returns last. When the returns go down, some of the weaker entrants will bail out.

"Those committed long-term, like Wal-Mart and Kmart, will not exit because they envision gas as part of their ultimate strategy. We've already seen it in Europe with hypermarketers giving major oil companies a hard time," he said. "At the end of the day, consumers will go to where they find value."

And that means more than just low prices. "Value encompasses other things such as convenience and safety, so I think there is room for co-existence," Gheit said. "Take the neighborhood hardware store as an example. You can still find them even though there might be a Home Depot in the same town."

Wal-Mart Weighs In
The stampede can already be felt in many parts of the country. Murphy Oil operates more than 300 fuel outlets at Wal-Mart parking lots, with another 100 slated for construction throughout the Southeast and the Midwest. Wal-Mart, which also partners with Tesoro Petroleum Corp. in the West, inked a deal late last year with Philadelphia-based Sunoco Inc. to build and operate fuel sites at its stores in nine eastern states. After a modest start, Sunoco plans to open as many as 100 per year over the next five years.

It's no surprise then that nearly half the states have BCP legislation. Yet, only nine -- including Tennessee, Wisconsin, Alabama and Florida -- are actively nforced, experts say. "It takes a strong DA [district attorney] to put some teeth in these laws," said Scott Dawson, a consultant and, until recently, business development manager for Oak Brook, Ill.-based Clark Retail Enterprises Inc., which operates as both a major c-store retailer and a jobber to grocery chains like Bi-Lo. "Some states like Florida have instituted tough laws but others have legislation that will be hard to enforce.

"The important thing to remember," said Dawson, "is that the hypermarketers are competing against themselves, not just traditional petroleum marketers. We've seen that happen in Europe and we're going to see it increasingly here as grocery becomes more of a global business. On the East Coast, for example, where Royal Ahold has a large presence, we're seeing a rift between the groceries and companies like Wal-Mart and Costco. Having worked in the grocery industry, I can tell you that their number one concern is Wal-Mart. They're as scared of Wal-Mart as a traditional c-store is of a grocery store that adds fuel pumps in their parking lot."

Many observers doubt the efficacy of BCP laws because "predatory pricing" -- at least the popular notion of it -- is often in the eye of the beholder. As one veteran marketer put it, "a lot of aggressive price competition is viewed as 'predatory' by those who are up against it. But it's a mistake to think that price is the only thing a customer looks at. Brand, convenience, advertising -- all of those factors play into the choice of fuel. I've got some customers for whom low price means an inferior product."

Others predict the shakeout of the downstream petroleum industry to continue. "The number of gas stations in the U.S. has continued to decline as retail margins have compressed," said Paul Latham, Costco's vice president of gasoline. "Large volume retailers have built-in traffic that can support higher-volume and lower-margin business models. Although the high-volume retailers in the U.S. will likely never achieve the kind of penetration we see in Europe, we will have an impact."

Channel Reaction
Different channels have responded in different ways. Grocery chains have positioned themselves as "lifestyle destination centers" with in-store banks, coffee shops, film developing, health and wellness sections, even day-care centers in some places. That gives them an edge on the discount clubs, which may lure consumers with prices but lack the aesthetics and amenities of supermarkets.

They've also taken advantage of their property lease and the economics of tearing out a few parking spaces to install fuel dispensers, a no-brainer that can yield immediate returns.

Some traditional operators are looking to hook deals with mass merchandisers, rather than confront them in a do-or-die battle for market share. For instance, Albertson's Inc. and ARCO have teamed up in Bakersfield, Calif. Dutch-based supermarket giant Ahold USA is primed to synergize its massive U.S. grocery holdings that include Stop & Shop and Bi-Lo with c-store holdings Golden Gallon and Wilson Farms Neighborhood Stores.

Even PMAA is approaching mass merchandisers and supermarket chains about developing a co-branded program instead of installing fuel pumps on their own parking lots. Many experts expect such alliances to grow among c-stores and smaller, independent grocers trying to keep up with regional giants.

The surge of hypermarketers, at minimum, has forced traditional retailers to enhance operations. "We've tried to do a better job of merchandising, better promotions, better buying, and lowering our cost of some products to increase our margins inside," said Kent, the Texas retailer. "Our focus is to try to get as lean as we can, to drive out inefficiencies in our business, to look at our processes and cut down every step we can.

Industry watchers encourage small marketers to capitalize on their ability to respond quickly to changes. "If I'm in this market, I have to look at the strengths and weaknesses of my competitors and determine where I can hurt them the most," Gheit said.

"I also have to look at my own portfolio to see where I'm weak or vulnerable. If they're competing on price, I have to offer my customers something other than price. It could be friendlier service, a snack shop, being open 24 hours, or a car wash. Whatever it is, I have to execute it every day," said Gheit.

"Small operators will have to pick their spots. They can't fight the behemoth face to face. But by offering better service and value, they can survive."
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