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C-STORES ADAPT, QUIT CENTERS

BY STEVE McLINDEN

The convenience store, once a force in small-to-midsize shopping centers, has largely grown up and moved out. Having outgrown its old end-cap role, it seems intent on living a stand-alone existence along the country’s byways.

While the mom-and-pop convenience stores can still be found in many strip centers, the industry’s real “pop” is coming from a different direction: new freestanding stores with broader aisles and merchandise selections, fast food, car washes and gas islands, say industry experts.

Because of that, it’s getting harder and harder for store owners to make their shopping center convenience concepts competitive, says Barbara Francella, senior editor of Convenience Store News. “And it’s not a primary strategy for chains,” she said.

Jim Christon, a Dallas-based leasing agent and developer of small-to-midsize shopping centers, says he no longer gets convenience stores as tenants in the Dallas area, which is considered one of the top convenience sales markets in the country.

“We used to do a lot of [shopping center convenience stores] for Stop-N-Go and 7-Eleven,” Christon said. “But the market has changed dramatically. The RaceTracs and Kwik Trips and the others have their big format now. If you do see a convenience store in a center, it is usually a small independent.”

Although industry leader 7-Eleven has recently unveiled a new urban prototype measuring about 1,500 square feet (less than half the national average of 3,200 square feet), the convenience store model seems to be headed the other way. Wawa, a regional convenience store operator with more than 500 stores, has been building 5,500-square-foot units, with some of its newer stores being as big as 7,400 square feet, says industry consultant Willard Bishop, CEO of Barrington, Ill.-based Willard Bishop Consulting.

In fact, the number of midsize-to-large stores (2,000-5,000 square feet) comprised 70 percent of the market in 1998 and 90 percent in 2002, according to the National Association of Convenience Stores. Chains are gravitating to broader aisles, better sight lines and roomier areas for such add-ons as financial-service kiosks and bakery departments, says association spokesman Jeff Lenard. “These days, in-store design is as important as external design.”

Site requirements have been expanded even further by the abundance of brush-free, quick car washes showing up on convenience store blueprints. These side businesses, which produce a clean and dry vehicle in minutes for as little as $3, are apparently paying off. They average a 78 percent gross profit margin, according to Convenience Store News.

REITs and other large property owners have, for the most part, minimal exposure to convenience stores now, says Matthew Ostrower, a retail analyst at Morgan Stanley. Franchise Finance Corp., the last REIT to have had a strong convenience store focus, is now defunct.

Carol Merriman, a spokeswoman for Vista, Calif.-based Pan Pacific Retail Properties, which owns and operates mostly grocery-anchored centers, says convenience stores are slowly disappearing from suburban shopping centers, though they’re still common in urban areas with heavy foot traffic. (The firm has no convenience stores in any of its 129 centers.)

In heavily populated portions of New York, Chicago and other cities where owning a car can be a liability, the old in-line convenience store, or bodega, still reigns, says the convenience store association’s Lenard. Most such shops, though having extended hours and enough variety to be considered convenience stores, nonetheless lack sufficient parking to serve motorists, he says.

The still-evolving convenience-store prototype emerged from a handful of early-20th-century retail concepts that have since mostly faded into nostalgia.

Over the years, the industry picked up elements of the old neighborhood grocery; the icehouse that predated modern refrigeration; the corner filling station that dispensed vending-machine candy, cigarettes and bottled soda; the butcher shop deli counter; and the dairy-and-baked-goods thrift shops, among other concepts.

Wawa stores have grown to house broader aisles and a wider selection of products and services.

But observers consider the real forerunner to today’s convenience store model to be the old Southland Ice Co., in the Oak Cliff area of Dallas. In 1927 icehouse operator Jefferson Green discovered that many of his customers also needed to buy such staples as bread and milk after hours. He began selling these items out of his shop at 12th and Edgefield streets, which was already open 16 hours a day, seven days a week. The idea went over so well that parent corporation Southland expanded it to its other stores.

As greater mobility, suburban sprawl and retail decentralization came to characterize post-World War II society, the new convenience-item format caught on around the country. Southland Ice, which later became 7-Eleven, set the modern standard.

Today, co-branded fast-food service is helping drive the convenience store fiscal formula, Bishop says.

“Food service offers gross margins twice as high as other in-store categories,” he said. “But the challenge is that it’s really a very different way of doing business. It’s cost-accounting versus retail accounting, and you have to bring in personnel and train them differently.”

Without food service, though, it’s hard for operators to make their numbers add up on premium properties, says Bryan Hall, a developer of gas station-convenience stores for California-based Highway Retail, a regional development firm.

“Those new stores cost about $4.5 million,” Hall said. “They are big and bright and attractive and clean, and they can really benefit from having a McDonald’s, a Taco Bell, a Carl’s Jr. or another fast-food tenant in them.” To get financing from the Small Business Administration, he adds, the same operator must usually run both the food and convenience store components.

At 1,500 square feet, 7-Eleven’s new urban stores are less than half the size of their regular units.

Jack in the Box may be establishing a slightly different standard with its own co-branded convenience store, Quick Stuff. Unlike other chains, which offer mini versions of their restaurants at fuel stations, the Jack in the Box-Quick Stuff format offers standard-size restaurants and full menus.

Convenience stores have not fared well with their traditional core “commodity” products in recent years.

The industry’s combustible mainstays, cigarettes and gasoline, aren’t yielding the profits they once did, and they show few signs of doing so going forward. That’s problematic, given that the two have historically accounted for three-fourths of all convenience sales.

Grocery chains and low-cost, big-box retailers such as Costco and Sam’s Club, which now operate street-side gas stations on the fringes of their property are cutting into convenience store petro sales, industry experts say.

“Business at the pump has become so cutthroat that a lot of convenience stores are investing more inside the store, with such things as full-service restaurants, delis and full coffee bars, taking advantage of those great real estate corners the best they can,” said Stephen Bittel, chairrman of Terra Nova Corp. and president of Petroleum Realty. The firms, both based in Miami, manage 8 million square feet of shopping center space and 100 convenience store-gas stations in eight states.

As for cigarette sales, they are getting choked by a different type of fringe competitor. “No one is increasing market share except remote sellers, who mostly operate illegally,” said Lenard. This includes those who buy in volume where cigarette taxes are low, such as in Virginia, which charges 3 cents, to then resell on the street or over the Internet to smokers in high-tax states like New York ($3 in taxes per pack) and New Jersey ($2 in taxes). Lenard also points to Forrester Research data indicating that one out of every seven cigarettes could be sold over the Internet by 2006.

Then there’s Wal-Mart, a name invoked in just about any retail debate, which pressures convenience stores both directly and indirectly, says Lenard. As Wal-Mart’s Murphy Oil stations put pressure on gas prices, the growing line of convenience items at its Supercenters and smaller, quick-hit Wal-Mart Neighborhood Markets are taking more traffic away from convenience stores.

“Not too long ago, Wal-Mart began to squeeze the profits out of the health and beauty product line, which was long a hallmark of drugstores,” he said. “So drugstores now look more like convenience stores because they were forced to change their mix. And, of course, that impacts convenience stores.”

As convenience stores depart shopping centers, dollar stores often take their place, says Eddie Liebman, senior vice president of The Weitzman Group, a Dallas-based commercial real estate brokerage. “Owners say they are just going to sell typical dollar-store items, but a lot of them end up selling sodas and snacks and many of the primary items that are sold by a convenience store. There is a lot of overlap.”

Other specialty retailers, too, such as office supply, sporting goods and pet stores, are routinely hawking snack items at checkout stands, creating additional competitive pressure, experts say.

Margaret Chabris, a 7-Eleven spokeswoman, says the competition “is the retailer near our store that sells like products. It could be a doughnut or coffee shop, a gas station, a drugstore or another convenience store — [it is] different for every store.”

On the gas sales side, the potential for environmental liability has also been driving some independent operators from convenience store fuel entirely, says Liebman. Pay-at-the-pump service presents a peculiar dichotomy for others.

Southland Ice Co., Dallas, seen in this 1927 photo, is believed to have been the first convenience store.

One operator resisted installing pay-at-the-pump service because competitors who had done so told him that motorists were just “getting gas and leaving without buying anything else,” Liebman said. “But then he found people were starting to go elsewhere instead of … waiting in line to pay [inside] at his store. It’s a double-edged sword.”

Today four out of five convenience stores offer gasoline, selling an average of 1.3 million gallons per store annually, according to the convenience store association. And about 60 percent of those offer pay-at-the pump service.

So far this year, rising wholesale prices are reducing fuel margins, which are already wafer-thin at barely 9 percent, say industry organizations. “It’s been proven time and again that as gas wholesale prices go up, street prices can’t move up as quickly,” said Daniel Gilligan, president of the Petroleum Marketers Association of America. “We have dealers and retailers being hit with several price hikes a week. The only way they recover [margins] is to hope prices don’t fall too quickly.”

Almost totally phased out are the gas stations that offer mechanical services, says Bittel. “Gone are the days when a guy with dirty fingernails gets out from underneath a car to come and ring up a soda,” he said. “That service requires hiring skilled workers … and it takes up a lot of square feet.”

Some national chains, however, are poised for conservative growth over the next few years.

7-Eleven, which operates or franchises about 5,800 stores in the United States and Canada, says it will open as many as 100 sites this year to increase its presence in some markets and to “replace stores we are closing due to profitability concerns and lease expirations,” said Chabris. “Most of those will be nongas and urban-type stores that focus more on fresh food.”

Petro Express, of Charlotte, N.C., says it expects to double the number of its convenience stores to more than 100 by next year.

Inevitably, convenience stores are faced with the long-term challenge of balancing the needs of their original customer base, the aging baby boomers, with the whims of Generations X and Y, consultants say. To do that in the food and snack categories, they must strike a balance between the health-conscious and the indulgent. Sometimes, they note, the two can be the same person — minding the diet early in the day and then rewarding themselves with high-calorie treats later.

The duality of 7-Eleven’s newest offerings, which range from controlled-carb Atkins products, SoBe Energy Slurpees and Prism Green Tea Soda, to ComfortCake, Dreammm Donuts and Go-Go Taquitos, seems to bear that out.

Prepaid calling card sales will probably continue to feed industry coffers, with those sales expected to exceed $6.4 billion by 2008, according to market data from Atlantic-ACM, a Boston-based business research-consulting group. Phone novelty items may also continue to be hot, as evidenced in part by some $1.3 billion in sales of downloadable ring tones in Europe last year, according to Strand Consulting, an international telecommunications consulting firm based in Copenhagen, Denmark.

And U.S. census data that show the Hispanic population will reach 55.1 million by 2020, or 17 percent of the total population, is likely to spur convenience retailers to tweak their mixes accordingly.

A convenience store that can find a way to add one-tenth of an item to the industry average of 2.1 items per transaction can add about $35,000 a year in sales, says consultant Bishop. “While that fraction seems small,” he said, “it points out that convenience stores need to look closely at every opportunity they can to grow their business in the coming years to stay competitive. You can’t overlook anything.”

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