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SOI 2019: Retailers Challenged to Change It Up

As the old c-store model becomes irrelevant, retailers have an opportunity to reinvent themselves
Photograph by Francisco Gonzalez

CHICAGO — On paper, the convenience-store industry seems unstoppable. 

In 2018, it broke the profit barrier for the third time in the past five years, hitting $11.0 billion, up 5.8% from the previous year, according to preliminary figures presented at the NACS State of the Industry Summit. Total sales rose for the third year in a row, up 8.9% to reach $654.3 billion. Gasoline pool margins, meanwhile, reached 23.8 cents per gallon (CPG), continuing a historic streak. 

“Who in the world would have thought … we would have a five-year run in fuel margins that would be between 22 and 23 CPG?” said Billy Milam, chief operating officer of RaceTrac Inc., Atlanta, and a presenter at the 2019 NACS State of the Industry Summit, held in April. “You’d have eyes rolling, heads shaking at you. No way is that going to happen. Well, it’s happened.” 

But despite this growth spurt, industry leaders like Milam have a sinking feeling that it’s not going to last. And it probably can’t last—not with the definition of convenience being redefined by unconventional retailers such as Amazon, through technologies that are reconfiguring the transaction. 

In fact, the ground underneath the industry already has shifted: For almost every month of 2018, total c-store customer transactions—fuel and merchandise—were lower than the same time the previous year. As a result, the industry saw 2.3% fewer customer transactions compared to 2017. 

“The underlying fundamentals may not be as healthy as we think they are, somewhat masked by 23-cent fuel margins,” Milam said. “The time to wean off dependency [on fuel] transactions is absolutely right now.” 

At the 2018 summit, presenter Andy Jones, president and CEO of Sprint Food Stores, Augusta, Ga., had sounded the alarm, warning that the c-store industry could be heading toward the wrong side of an S-curve. The S-shaped graph is commonly used to track the rise and fall of an industry over four phases: inception, growth, maturity and, finally, the dreaded saturation phase, when growth under the current model slows and ceases. 

Step back from the c-store industry’s recent sales tear and its longer-term growth trajectory starts to look an awful lot like an S. It’s a sign, Jones, Milam and other industry leaders believe, that the channel’s traditional offer is getting stale. 

“The gas, Cokes and smokes model—it’s done,” said Milam. “You’ve got to continue to innovate.” 

That’s not to say that some convenience retailers aren’t hustling. The top quartile of c-store retailers by store operating profit sold more than $75,000 in foodservice per store per month in 2018, compared to an industry average of $22,104. Their fuel gallons averaged 230,806 per store per month vs. about 159,336 for the full industry. But this top 25% of operators is the exception rather than the industry norm. 

“Remember: Our industry is only as good as our weakest link,” Milam said. “So while some of us are doing a tremendous job of changing, innovating, driving retail—forget convenience, but driving retail—a lot of us are being left behind. They’re not innovating.” 

This gulf between the industry’s top and bottom performers illustrates this. The top quartile enjoyed more than 10 times the store operating profit, nearly six times the foodservice sales and 2.6 times the fuel gallons of the bottom quartile. Its breakeven on fuel was nearly 12 CPG lower. 

“Just for getting out of the bed in the morning, they have a 12-cent inherent, implied advantage over the bottom quartile,” Milam said. 

The competitive pressures extend beyond the c-store across the street, of course; perhaps the more formidable opponents are in other channels that sit further to the left on the S-curve—specifically, dollar stores and e-commerce retailer Amazon. Dollar is the fastest-growing retail channel, with store count up 35% in the past seven years. 

And should it hit the 3,000 locations that media reports suggest are in the works, Amazon Go would become the fourth-largest c-store chain in the United States. 

For c-store retailers who are part of the bottom quartiles, the next decade will make or break them. 

“The bottom half is still in a 10-year-old business model,” said presenter Charlie McIlvaine, chairman and CEO of Coen Oil, Canonsburg, Pa. “They haven’t evolved. The top quartile has. If the last 10 years were hard, the next five are going to be harder.” 

Size Up

As dollar stores continue to add locations at a brisk pace, c-store growth has stalled. After several years of steady increases, the industry posted its first decline in store count in 2018, according to figures from NACS and Nielsen/TDLinx. The 1.1% drop happened mainly among single-store operators—down 2,198 sites—as some retailers sold their land and others sold their businesses. 

Another shrinking segment: chains with 200 to 500 stores, which fell by 2,100 locations. For both size segments, industry consolidation was a contributing factor, Milam said. Backing up this claim: The 16 c-store chains with more than 500 locations saw a 2,600-site increase year over year. 

And the rate of consolidation is increasing. The number of chains with four or more stores, which topped 2,000 about a decade ago, has fallen by 28% to just over 1,400. Within the past four years alone, there has been a 19% decline in the number of these chains. The mix of the top 20 chains includes private-equity backed companies such as GPM Investments, international retailers such as EG Group and several “super-regional” family-owned operators such as Wawa and QuikTrip. 

There are signs that the consolidation is benefiting mainly the largest chains. In 2015, GPM Investments LLC, Richmond, Va., ranked as the 20th largest c-store chain with 463 stores, Milam said; in 2018, the 20th largest chain was United Refining Co., Warren, Pa., with 348 sites, he said, referencing CSP’s latest Top 202 update. “That’s an indicator, a weak signal telling me we’re getting a little more top-heavy than we’ve ever been, and that trend’s been going on for seven years now,” Milam said. 

The attractiveness of c-stores as an acquisition target is backed up by the industry balance sheet, with in-store sales rising 2.2% to $242.2 billion and fuel sales jumping 13.2% to $412.1 billion on rising fuel prices. And then, of course, there is the profit number. “We’ve never touched $11 billion before, ever,” Milam said. 

Peel back the layers, however, and there are some “ugly” elements. For example, even as industry profits hit a record, credit-card fees rose even faster, up 9.9% to reach $11.1 billion. 

“Put another way, [that’s] $100 million more than our industry took to the bank last year,” Milam said. “What ways can we attack this? The No. 1 highest operating expense is your people. No. 2 is credit-card fees. That’s a big freaking number, and a bit of innovation around the fringe can go a long way to addressing the profitability and opportunity.” 

That No. 1 operating expense—labor— has become an obsession for c-store retailers as national unemployment hovers under 4%. Wages and benefits rose 3.7% in 2018 to reach $31,742 per store per month, according to CSX figures. Since 2014, wages for store associates have risen 19%, hitting an average $10.74 per hour in 2018. This is higher hourly pay than offered by many of the largest dollar, drug and quick-service operators, but the c-store industry is still afflicted with a turnover rate higher than fast food and supermarkets. The turnover for a c-store associate is 118%, compared to a total retail baseline of 59%. 

“We can find qualified people and can get them into our programs and start the training,” Milam said. “It’s the retention component that’s so hard. When we find them, how do we keep them? An engaged workforce drives higher profits.” 

The top-quartile operators demonstrate this. Even though they had a higher labor cost per hour—$17.72 vs. $14.76 for bottom-quartile retailers—they earned significantly higher in-store gross profit dollars per labor hour. In 2018, the top quartile earned $39.16 per labor hour vs. $21.20 for the bottom quartile. 

“So while they’re paying almost $3 more in labor costs per hour, the top quartile is making an incremental $17 to $18 off that $3 they’re paying,” Milam said. 

Fuel Down

Another segment of the business that posted some impressive numbers in 2018 but has underlying weakness is fuel. Pool margins rose to 23.6 CPG in 2018, according to CSX, up 0.2 CPG from 2017. Gallons in 2018 were off 0.4%, even as sales rose 13.2%—along with a 13.7% increase in the average selling price. 

Fuel consumption in 2018 was up slightly from 2017, and it is tracking slightly down thus far in 2019, according to the Energy Information Administration. It’s not going gangbusters, but it’s also not the dip in demand retailers saw in early 2017. 

At the same time, vehicle miles traveled (VMT) is growing, up 2% over the past three years, according to the Federal Highway Administration. The flattening demand in the face of rising VMT seems contradictory. But in this case, regulatory forces are at work: Corporate Average Fuel Economy (CAFE) standards are rippling across the U.S. vehicle fleet as it turns over.

"The time to wean off dependency [on fuel] transactions is absolutely right now."

Milam pointed to the Ford F150—the best-selling vehicle in the United States—as an example of how transformative CAFE standards have been to fuel demand. The 2007 model-year F150 had a combined fuel efficiency of 16 miles per gallon (mpg). The 2019 model-year pickup truck had a 22-mpg combined fuel efficiency. This 37.5% jump in fuel efficiency equates to nine fewer fill-ups per year—and does not factor in any store purchases that would have accompanied those trips.

So while sales of electric vehicles may be growing—albeit off a small base—“CAFE standards really are going to drive down the amount of fuel we’re selling,” Milam said. “Are we seeing any of those inflection points yet?”

Categorical Success

Despite these scary signals, this is not the c-store industry’s first dance with disruption. Ten years ago, retailers saw historically low fuel margins, gas prices pushing $4 per gallon and the worst economic crisis since the Great Depression, Jones of Sprint Food Stores reminded attendees. Adding to the discomfort: Consumers were moving toward healthier eating. “We were not selling kale salads back then,” he said.

And then there was the debut of the first smartphones, which quickly deflated c-store sales of paper publications, maps, magazines, newspapers, audio tapes and film. Combined, these subcategories had contributed nearly $22,000 per store in sales, or $3 billion for the total industry. “Not to mention how it destroyed another traffic driver: When was the last time someone came in our stores and asked for directions?” Jones said.

“How could our industry possibly survive what was taking place in 2008?” he said. “But over the past decade, we didn’t just survive; we prospered. Because we found new product categories and were able to evolve our offer.”

These new products include energy drinks, which grew from a minor segment within alternative beverages to a $5.9 billion juggernaut within a decade, bringing in more than $83,000 per store per year in 2018, according to figures from Nielsen and CSX. Prepared food, which 10 years ago generated $130,000 in sales per store, has more than tripled to $375,000. Total foodservice has expanded from about 16% to more than 22% of in-store sales, even as tobacco has slipped. 

“When you hear about disruption, that shouldn’t sound scary. It should make us think about opportunity,” Jones said. “What new products will drive our sales over the next 10 years?”

One that has potential: products containing cannabidiol (CBD), the nonpsychoactive ingredient in marijuana and hemp that is said to have therapeutic effects. With the passage of the 2018 Farm Bill, hemp is no longer considered a Schedule 1 drug—the category reserved for drugs such as heroin, LSD and cocaine. That said, the U.S. Food and Drug Administration (FDA) does not currently consider CBD a permissible ingredient in most food, beverages and supplements.

NACS has advised retailers to proceed with caution on CBDs, although these products will be on display at the 2019 NACS Show. Meanwhile, other channels are forging ahead, with both Walgreens and CVS adding hemp-based CBD products to hundreds of their stores. And while internet retailers are expected to own the majority of CBD sales, “They have no ability to age-verify,” McIlvaine said. “We’re probably the best to do it.

A New Model

Within the legacy categories, there is room for growth as regulatory and competitive pressures mount. The top six categories—tobacco, foodservice, packaged beverages, snacks, beer and candy—supplied 92% of in-store sales.

Cigarettes, the largest in-store category by dollar sales, declined 3.1% in 2018, according to CSX. Gross-profit dollars fell 4.6%. Within other tobacco products (OTP), e-cigarettes surpassed the sales contribution of cigars in 2018, according to Nielsen figures. 

However, OTP faces a regulatory reckoning, with the FDA proposing to restrict sales of flavored e-cigarettes to online, vape shops and adult-only retailers. Also, flavored cigar products introduced after 2016 that have not received FDA approval would face removal or enforcement actions. Considering that flavored and menthol varieties make up the bulk of e-cigarette sales and roughly half of cigar sales, the impact on these products and c-stores would be massive. 

In foodservice, the next largest category by share of in-store sales and the largest by profit dollars, there was growth in both metrics. Prepared-food sales grew 4% in 2018, while gross-profit dollars rose 4.5%, according to CSX. However, sales of hot dispensed beverages dropped 4.5% and gross-profit dollars fell 3.9%. McIlvaine pointed out that the drops are coming from customer traffic in other channels. “[Quick-service restaurants] used heavy promotions to draw traffic in, with a focus on coffee,” he said. 

And in alternative snacks, meat snacks are supplying the growth in c-store sales, driven by the popularity of the high-protein paleo and ketogenic diets. But c-store sales of other subcategories—bars and other alternative snacks—are dropping. McIlvaine cited competitive pressures for the erosion in sales. 

“C-stores are getting displaced,” he said, pointing out that Amazon’s top growth categories are snacks. “[Customers] might be ordering in bulk instead of coming to our stores.” 

The convenience industry has some decisions to make. Does it stick with the current fuel- and commodity-driven model that has a one-size-fits-all offer and limited transaction models? Or does it transition to a service-driven business that offers variety in energy and products, as well as a tailored, frictionless experience? For a channel as fragmented and top-heavy as convenience stores, the answers will likely be very different depending on the operator. 

“Have we as an industry entered that S-curve, the slowdown, saturation piece, that fourth phase that any industry tends to go through?” Milam said. “I don’t know we have—there are opportunities to innovate and change and continue to do so. The leaders in our industry are doing a tremendous job of that. But you’re only as strong as your weakest link, and there are a lot of weak links in our industry. So how do we bring the entire industry along?” 

Key 2018 Metrics

Total c-store sales rose 8.9% in 2018 thanks to a more than 13% jump in fuel sales, pumped up by higher gas prices. Fuel margins rose more than 7% to 23.35 CPG, marking another year above 20 CPG. 

Metric20172018% change
Store count154,958153,237(1.1%)
   • Inside sales$237.0 billion$242.2 billion2.2%
   • Fuel sales$364.1 billion$412.1 billion13.2%
Total sales$601.1 billion$654.3 billion8.9%
Pretax profit$10.4 billion$11.0 billion5.8%
Credit-card fees$10.1 billion$11.1 billion9.9%
Employees 2.38 million2.36 million(0.8%)
Fuel margin (CPG)21.7323.357.5%
   • Net of credit-card fees (CPG)16.9018.026.6%

Sources: Nielsen TDLinx and NACS preliminary data. Final data to appear in the NACS State of the Industry Report of 2018 Data. 

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