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FAMILY DOLLAR TAKES A SECOND LOOK AT URBAN STORE STRATEGY

By Rodger Brown

There was no use denying it. Family Dollar, the country’s second-largest chain in the once red-hot dollar-store sector, had stumbled. “[What] happened in ’05 was, we had a few missteps,” said R. James Kelly, Family Dollar’s chief financial and administrative officer, speaking to a group of investors in October.

A push into urban markets turned out to be harder than Family Dollar had expected, a major shift in the merchandise mix was overwhelmingly rejected by its customers, and shrinkage — inventory loss through employee pilferage and shoplifting — had run wild. Taken together, these difficulties helped drag profit down by 30 percent year on year in the last quarter of fiscal 2005.

To their credit, company officials have not tried to put too much spin on the tale of their misfortunes, says Christine Augustine a Bear Stearns analyst who in a note to investors wrote off Family Dollar’s bruising 2005 as a “transitional year and an investment year,” acknowledging that “management admitted it made mistakes.”

Now, in keeping with Southern tradition, the discount retailer born 46 years ago in Charlotte, N.C., and still based near there, has hitched up its britches and gotten back to work, Kelly told investors.

As Wal-Mart grew to become the nation’s largest retailer in the 1980s, Family Dollar found its place by focusing on the low-income consumer. The small, convenient stores became destinations designed to complement Wal-Mart’s game plan.

“We created a niche that works well within Wal-Mart’s shadow,” Kiley Rawlins, Family Dollar’s divisional vice president of investor relations, explained to SCT. “As Wal-Mart has become more convenient by offering one-stop shopping, we have tried to provide convenience through being able to get in and out quickly. We tend to coexist well.”

From roughly 700 stores in 1984, the chain more than tripled in size over the next decade. Between 1995 and 2005, Family Dollar’s growth accelerated, with the chain adding more than 3,000 stores, and most of those coming on-line in the past five years.

And it’s not done yet. “There’s tremendous opportunity for growth, and, indeed, we believe there’s clear visibility for an at least doubling of our chain,” Kelly told the investors.

Part of that opportunity lies in the growth of its customer base — households earning $25,000 a year or less, a category that has increased 10 percent over the past five years. Low-income families headed by a woman, a subset of its target, have risen by 7 percent.

That is a mixed blessing, though, because whether this group is located in small towns or urban areas, it offers little by way of discretionary spending on high-margin items, and finding the right merchandise mix for basic consumables leaves little room for error.

Still, the company is determined to refine its model to offer value and service to this challenging demographic. The first step is to find such customers, and since the beginning of the decade, Family Dollar has looked to urban markets with populations of 200,000 or more.

Family Dollar’s enthusiasm for urban markets began when it noticed that its stores in metropolitan markets did better than similar-size or larger ones in small urban or rural areas. At 7,500 square feet to 9,000 square feet, they fit into a built-out urban landscape as no Wal-Mart or similar big-box discount retailer could. In 2002 Family Dollar outlined a plan to put 65 percent of its new stores in urban markets.

But performance in the urban stores was inconsistent. Well-managed stores were showing same-store gains, while others slipped through the cracks with flat or declining sales. This year Family Dollar earmarked $20 million for an “urban initiative” to reorganize management, implement new technology, introduce employee incentives, improve screening and hiring and reduce theft. In August, however, the company froze the program, which by then involved some 1,300 stores and saw costs spiral to nearly $25 million. The program is not terminated, the company says, just on hold.

“We are seeing a lift in sales from the [urban initiative] program, enough to cover our costs,” said Rawlins. “But the intention was to drive higher profitability and higher returns. So, we’re going to step back in ’06 and re-evaluate our processes to focus on really driving higher returns from these stores going forward.”

Theft was a particular problem that is now being addressed, the company says. A key competitor, Dollar General, had tried and abandoned a similar strategy, ultimately retrenching in its preferred small-town, 25,000-and-under markets. Kelly acknowledged that Family Dollar failed to learn from Dollar General’s mistakes.

Rawlins later elaborated, explaining that the company is addressing the problem with technology for monitoring each transaction. “We expanded our loss-prevention department to better support some of those more challenging markets, like urban markets or other markets that are underperforming” because of theft.

Further, sales plummeted as a result of a miscalculated effort to de-emphasize name-brand products and introduce more generic and private-label products. “We made assortment changes last spring that were not as well accepted by our customers as we had planned,” Rawlins said. “We went back and eliminated those items not doing well and added some additional brand names and saw our same-store sales in the consumable area rebound to previous levels.”

Again Kelly was blunt. “We took a sector of our business that’s roughly almost half of the business and drove it ... flat almost overnight,” he said. “Not something we’re proud of. We’ve learned a lot of lessons on that.”

One of those lessons was that a management shake-up was needed. In August, as shares reached a four-year low, President and COO David Alexander resigned, and CEO Howard Levine took a more hands-on approach, according to Rawlins.

With the “transition year” and a brutal round of self-scrutiny behind it, Family Dollar has reasons for optimism. In January it began introducing refrigerated cases for stocking perishable food products in about 1,000 stores to help drive traffic, and the response has been “very, very solid,” Kelly says. The company says it plans to bring in an additional 2,500 next year. To help make up for the low-margin consumables, Family Dollar also plans to continue promoting its successful Treasure Hunt program, an industry nickname referring to the periodically stocking close-out or imported items that customers didn’t expect to encounter in the stores. The Treasure Hunt program, in Kelly’s words “add[s] excitement to the shopping experience,” as well as higher-margin luxury items that help make up for the stores’ low-margin staples.

New warehouses have improved distribution and saved on fuel costs.

“Our business has significant growth potential,” Levine concluded in an e-mail to SCT. “The low- and lower-middle-income population segment continues to grow at a rapid pace, and the dollar channel is experiencing an increase in acceptance from a broader customer base. We continue to make strategic investments in our business that position Family Dollar to better serve the needs of our customers.”