Wall Street cautious about future club growth - Goldman, Sachs and Co. retail analyst George Strachan - Warehouse Club Closeup

Discount Store News, March 1, 1993

While warehouse club industry sales growth continues to outpace other retail channels, some financial analysts are beginning to worry that the market for clubs is becoming oversaturated.

"Are warehouse clubs still a growth industry?" asked George Strachan, retail analyst for Goldman, Sachs & Company.

There are few sites that get a retail analyst's heart pumping more than a warehouse club that is smoking on a Saturday morning," said Strachan as he begin listing the past achievements of the club industry.

However, the analyst pointed out that there's been an alarming slowdown in comparable unit sales growth in recent years. This slowdown has been caused by: * Heightened industry competition; * Increased self-cannibalization of sales; * Slow price inflation, particularly in food; * A weakened small business sector; * Absence of new merchandising initiative after fresh food; * Improved competitive response; * A less value-conscious consumer.

Strachan pointed out that much of the self-cannibalization in the industry is by design. "[Wal-Mart chairman and driver behind the development of Sam's Club] Dave Glass told me, "There are few more futile activities that I can think of than trying to drive sales at a club unit from $100 million to $150 million. It's much better to open new clubs and cannibalize your sales.'" - thus, increasing total market share.

Referring to the lower price inflation factor, Strachan noted that "it's difficult to cover normal operating cost increases during a period of low price inflation." However, he did add that this is likely to be a cyclical phenomenon.

More significant for clubs is the fact that the last few years have been "devastating" for small business owners. Business failures have increased from 49,000 in 1988 to 96,000 in 1992 while new business formations have been flat or declining over the same period of time.

Strachan also predicted that clubs will have to take a closer look at their merchandising strategies. "Merchandising and marketing have always been the step-children of the club industry," said Strachan. At the same time, clubs must be cautious about expanding into more discount store-type products because of the wider assortments and cost of maintaining these merchandise categories.

The introduction of fresh goods was the last merchandising breakthrough for clubs. Fresh foods added about 5% to 10% directly to club sales, as well as another 5% to 10% indirectly through increased traffic and sales in other departments.

Strachan also warned clubs not to go too far into private label. "The danger of franchise erosion needs to be monitored closely," he said. "Afterall, clubs must remember that they built their franchise with brands."

The best example of a category dominant retailer that has successfully adopted warehouse techniques is The Home Depot, observed Strachan. Similar competitive responses should be expected, particularly by the supermarket industry. However, "we do not feel that club aisles at supermarkets have done much to impact warehouse club sales."

He identified Hannaford's Shop & Save program as one of the better supermarket efforts to counteract clubs, although that is more of a marketing-oriented response than actually club-oriented.

Value consciousness on the part of consumers may also be a cyclical phenomenon. "Comp-store sales in department stores this holiday season rose 10%," Strachan pointed out. "So people may be less value conscious than many of us expect."

As for the future, Strachan predicted that clubs will: * Expand more modestly; * Continue to self-cannibalize sales; * Pay closer attention to the cost side of their business; * Add more member services, but members must pay for them. (Pace, for example, is reportedly considering adding dry-cleaning services on the premises); * Focus more on merchandising and marketing; * Expand internationally. Sam's unit in Mexico has generated higher sales per square foot figures than any of its U.S. units," said Strachan. * Improve convenience to members, such as automatic check writer (as at Price Club), acceptance of credit and charge cards, extended hours and more scanning to quicken checkout.

Strachan uses the Price Co. as evidence that industry growth will slow somewhat over the next five years. Price's average sales per unit declined from $116.4 million in 1989 to $95.3 million in 1992, while its net income growth (excluding real estate gains) fell from a 24% gain in 1989 to just a 4% increase in 1991, and was down 8% in 1992.

Nevertheless, the analyst still places Price among the industry's three strongest participants because of its high sales per unit, formidable position in key markets and strength as an item merchant.

The other two clubs highlighted by Strachan were Sam's for its economies of scale, low-cost operation and pricing flexibility in less-competitive markets, and Costco, which has a uniquely strong market position in the Pacific Northwest, is an innovative merchant and has a very flexible organization.