What Recovery?

A turbulent year for the economy has raised some serious questions about what we can expect in terms of a post-recession rebound. What does this mean for pet specialty retailers as the calendar flips to 2012?


What a difference a year can make.

Going into the fourth quarter of 2010, many economic prognosticators were heralding a long-awaited, albeit gradual, recovery from the recessionary forces that took hold in 2008. Many suggested that retailers only had to wait a few more months for consumers to once again start purchasing product at a robust rate.

But predictions of recovery were clearly premature. In fact, as retailers find themselves on the cusp of another holiday selling season, many find that the economic picture has gotten even gloomier over the past 12 months. And now it appears that the situation may get even worse before it gets better.

What is probably most surprising about this divergence between what the experts were predicting at the end of 2010 and the reality that retailers find themselves facing today is that for the first half of 2011, those who were bullish on economic recovery appeared to be correct—at least at the retail level. As the year opened, retailers were coming off a holiday season in which the National Retail Federation (NRF) says that sales rose 5.7 percent over the previous year (the best retail sales gain since 2004, according to the organization). Things were looking good when similar growth was reported as spring blossomed and then gave way to summer.

According to NRF, the retail industry was posting sales gains of around 4 percent as late as July. And if PetSmart’s performance during this period was any indication, pet specialty stores were benefitting just as much, if not more, than their counterparts in other channels. PetSmart reported a 5 percent increase in comparable store sales for the second quarter of 2011 and a 7.6 percent gain in services sales.

However, as July turned to August, there was a noticeable shift in the economic picture. National discourse turned to debt ceilings and government defaults. And although that particular crisis was temporarily averted, the bad news continued into late summer. The stock market became dangerously volatile around mid-August, with the Dow swinging up and down by more than 500 points in a single day. Hurricanes battered the mid-Atlantic and northeast, as well as the Gulf Coast, taxing already cash-strapped state and local governments and highlighting sorely needed infrastructure improvements.

The White House warned the country to expect the unemployment rate to stay above 9 percent for at least another year, and it may not get to the 6 percent level until 2016. A European debt crisis sent financial markets into a tailspin and spurred experts to speculate that we could be headed for a global recession (Nobel-prize winning economist Paul Krugman put the odds at 50 percent).

It is no wonder why consumer confidence has become frayed.

 “In our August survey, we found that consumer confidence is at its lowest level since March 2009, so we’re talking recession levels,” says Pam Goodfellow, consumer insights director for BIGresearch, a Worthington, Ohio-based market-research firm. The company’s August survey revealed that the consumer confidence level was just over 20 percent, a dramatic decline from last year’s level of 30 percent and a frightening departure from pre-recessionary levels, which are typically around 40 percent. It also revealed some of the biggest issues driving this trend.

“Official unemployment being over 9 percent is still weighing heavily on consumers,” says Goodfellow. “In August, 40.5 percent [of consumers polled] thought that there would be more layoffs over the next six months. A year ago, that number was only 28.9 percent. And when you worry about your job, it affects your spending.”

Impact on Pet Stores
So what does all of this mean for retailers as they prepare for the upcoming holiday season and 2012? For most, it means tempering expectations. “It’s safe to say that it’s not going to be a banner year for retailers,” says Goodfellow, who predicts that retail sales will likely be flat, or possibly show some modest gains, this holiday season.

David Lummis, senior pet market analyst for Packaged Facts agrees. “I haven’t seen anything in particular that makes me feel like there will be a big rebound, including in the pet market,” he says.

But there is hope for pet stores. Goodfellow says that despite the country’s current economic struggles, consumers are increasingly considering the true value proposition of their purchases, as opposed to simply focusing on price—a trend that clearly benefits independent pet stores. “Quality is factoring in more than it has over the past couple of years as consumers have realized that it is something that they have compromised [by focusing on price] during the recession,” she says.

According to Michael Levy, co-owner of Pet Food Express, a pet specialty chain with more than 35 stores in the San Francisco Bay Area, pet stores can also be heartened by the fact that consumers still want to do right by their four-legged loved ones. “The good news is we’re very fortunate to be in this industry,” he says. “I continue to believe that the pet industry is recession resistant. People are going to be conservative when it comes to buying new cars, fixing up their homes and taking expensive vacations. What does that mean? It means they’re going to continue staying home more and continue to focus on taking care of their families, and pets are part of that.”

However, it would be a mistake to assume that this trend will indefinitely sustain the type of growth the pet care market has enjoyed over the past decade, says Lummis. “We’ve had this wonderful pet-humanization trend that has created growth, but that has really been driven by higher-income demographics,” he says. “But in 2009, we saw the $70,000-income household segment, which had doubled its share of aggregate pet market spending over the previous 10 years, actually decline.

“You cannot ignore the possibility that we have reached some sort of ceiling, in terms of how many of those higher-income households can be converted.”

The Incredible Shrinking Margin
One area in which independent retailers have faced a particular struggle over the past few years has been in their profit margins. As food prices have steadily increased and consumers’ wallets have tightened, many pet stores are finding that their customers have less to spend on discretionary purchases because they refuse to compromise in meeting their pet’s nutritional needs.

“Consumers realize that they have a limited budget,” says Goodfellow. “So if they’re going to spend a little bit more [on the essentials], they’re going to have to cut back on [luxuries].”

Unfortunately, price increases represent a pet industry trend that shows no signs of slowing. “I see a whole new round of price increases coming, whether it’s at the end of this year, or the first quarter of 2012,” says Levy. “I would say that all of the foods are going up, and there will be increases in a lot of other categories as well.”

Obviously, independents cannot afford to sit back and watch their margins continue to erode. Steps must be taken to remove some of that pressure.

“There are creative ways to approach [the problem of shrinking margins],” says Neil Werde, president and COO of Quaker Pet Group, a company that manufactures a wide range of pet products. “Let’s have a conversation with the retailer, distributor and manufacturer together in a room to figure out where we need to be to keep all three happy and in business. For example, maybe we can we can work with the distributor and the retailers to set some kind of staged pricing structure to provide discounts if a certain level of business is reached.”

When it comes to easing the pressure created by shrinking margins, retailers would do well to emulate their distributor partners, which are seeking relief within their own operations.

“The strategy that we’ve largely seen among distributors is looking for efficiencies in their operations,” says Steve King, president of the Pet Industry Distributors Association. “They’re doing everything they can to take some of the cost out of the channel, whether it’s through the technology that they adopt or through efficiencies that they can create by getting bigger.”

Distributors’ efforts to find operational efficiencies, says King, hold some direct benefits for retailers. “Distributors continually work to provide good deals for their retailer customers, based on the things that help the distributor to more efficiently serve the customer,” he says. “So, for example, if you’re willing to place more of your business with a distributor, you’re going to be more valuable to that supplier. If the deliveries that are being made to your store are larger, that distributor is going to be able to service your store more efficiently and cut some of their costs. And that can get passed down the line.”

Survival Skills
When dealing with the many challenges posed by the current economic environment, it is essential that pet retailers keep an optimistic attitude and continue to work hard to drive their businesses forward. When sales are not meeting expectations, it is far too easy to fall into a malaise—something that Levy says retailers should avoid at all costs. Instead, he says, storeowners should focus on the qualities that made them successful in the first place.

“We have no control over the economy, and I have always been a big believer in focusing on the things you can control and improve,” says Levy. “Maybe it’s getting out of your office and into the store and talking to customers, doing sales. I would like to think that the pet shop owner would be the strongest salesperson in the store. So, if you really need to build up your sales, get out on the floor.

 “Pet retailers have to go back to the basics,” Levy continues, conjuring images of the small neighborhood pet shop, where a knowledgeable storeowner/employee offered customers valuable guidance on the topic of pet care. “The customer felt like that storeowner cared, like they had great knowledge. And they wanted to help that neighborhood store. If you can create that kind of environment, not only can you survive, you can grow.”

Luckily, independent pet retailers don’t have to go it alone. They will continue to get assistance from their suppliers in the form of product innovation, which has always been a major factor in driving industry growth.  “The rate of new product introductions is still going very strong,” says Lummis. “There has not been a drop-off.”

Pet food is one category in which product innovation has been particularly valuable in helping independents compete against other retail channels; and this trend is expected to continue. 

“There will continue to be innovation in food, which is one of the key driving elements of our industry,” says Levy. However, he notes, maintaining this level of innovation will become tougher in coming years, because, “there is a limit to how much better you can make [food products] and keep them in an affordable price range.”

But for now, independents still hold a significant edge over supermarkets and mass merchandisers when it comes to appealing to more discerning consumers in the pet food category, says Lummis.

“Over the next two or three years, there is still going to be a pretty distinct divide between the products that are available only in the pet specialty channel and those that are available at mass,” he says. “Especially considering the fact that those products are geared more toward higher-income consumers who are very concerned about safety and ingredients—basically, people who do their homework. So the pet specialty channel is still on very strong ground. ”

Another area in which Lummis sees ample opportunities for small, independent pet shops is healthcare products—a category that he notes has been around for years but isn’t being fully leveraged by pet specialty retailers.

“Something that has really come to my attention is just how underdeveloped the pet health departments are in most pet stores,” says Lummis. “A lot of stores do have a pet health department that is a mixture of supplements, flea and tick products and other over-the-counter remedies, but they’re just not real pretty. They don’t have the feeling of a serious category. There is a lot of room for improvement.”

Lummis says that pet specialty retailers shouldn’t underestimate the potential that the pet health category can hold for their businesses. “Pet health products are less discretionary, more essential,” he says.  “And they work well in helping to fend off competition from other channels with less knowledgeable sales personnel.”

The senior-pet category holds similar untapped potential, says Werde. “Close to 50 percent of all pets are seniors,” he says. “And while there are some products out there, there is no section at retail that caters to all of the demands of making a senior pet’s life (and its owner’s life) easier. [The senior-pet category] has been scattered throughout the store.”

Whichever product categories a pet specialty retailer chooses to focus on to drive growth, industry observers say that the key to success lies in stocking only products that offer a strong value proposition to consumers. “Limit the assortment and make it the strongest assortment that you can,” says Werde. “Everything is going to have a really compelling marketing story, and it will have to go a little bit beyond a fun aspect.”

And wherever possible, independent pet shops should look for unique brands that will set them apart from the competition, suggests Levy. “Work on relationships where there is synergy,” he says. “There are a number of very good small brands out there that are not all over the place. Build those brands, one customer at a time, and that will open up opportunities.”

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