The Bigger They Are...
PetSmart and Petco have dominated the retail pet care market for the past 20-plus years, but the tide may be turning against the two big box stores as other retailers get more savvy and consumer's tastes change.
PetSmart’s largest investors do not appear very happy.
In a recent letter to the company’s board, Jana Partners, which holds a 9.8-percent stake in the big-box pet chain, scolded the company for “years of operational and strategic missteps” and urged “a full review of all strategic alternatives including a sale.” The letter cites a weak e-commerce presence, suboptimal pricing structure, inadequate cost management, a failure to develop new store formats and a lack of product innovation as some of the major issues plaguing the PetSmart. It also notes that the result has been a steady decline in the company’s market share in the retail pet care category.
The evidence appears to back up this last assertion. According to the 2014 Pet Stores in the U.S. Industry Report from IBISWorld, a global market research firm, Phoenix-based PetSmart, which operates more than 1,300 stores in the U.S. and Canada, has seen its market share fall to 41.9 percent from 43.1 percent since 2012, after years of steady growth.
“PetSmart has had a softer 2013 and 2014 than the years immediately following the recession, when it was posting annual gains of well over five percent per year,” says IBISWorld analyst Andy Brennan, the author of the report. “The company is coming under increasing pressure from online operators and broad line retailers like Walmart. However, the whole industry is dealing with the same competitive threats.”
Of course, getting a clear picture of Petco’s health is difficult, given its status as a privately held company. However, industry observers do appear more bullish on Petco’s prospects for further growth, with some even pointing to the company as the best potential suitor for a possible acquisition of PetSmart.
According to IBISWorld, San Diego-based Petco, which operates 1,200-plus stores in the U.S., has fared somewhat better than PetSmart. The company’s market share dropped slightly to 20.6 percent from 20.7 percent between 2012 and 2014. However, this does represent a reversal of the growth that Petco experienced between 2010 and 2012, when its market share increased by nearly one percent.
The Big Squeeze
Escalating competition from both inside and outside the pet specialty channel seems to be the key issue, when it comes to the recent difficulties experienced by the big boxes. Outside the channel, retailers in grocery and mass—and other channels—have increasingly looked to capitalize on the relative strength of the retail pet care category by emphasizing assortment, price and especially convenience.
“Everybody is getting into the pet business,” says Biff Picone, owner of Natural Pawz, a Houston-based pet specialty chain with 15 stores. “If you look at where Petco and PetSmart were 10 years ago, they pretty much dominated the pet segment the way Home Depot and Lowe’s dominate the hardware business. But over the past 10 years, grocery has stepped up its participation in mainstream pet products.”
Part of this stepped-up participation includes refining the product mix of grocery and mass retailers to better meet the evolving demands of pet owners—a trend that is significantly impacting the competitive balance within the pet segment, says Maria Lange, senior product manager for GfK, a market-research firm that specializes in the pet specialty channel. “The ‘premiumization’ outside the pet specialty channel is underway,” she says. “Grocery and mass retailers are offering more and more premium products, when it comes to pet food—for example, natural and grain-free foods.”
Lange notes that the “premiumization” of grocery and mass retailers’ pet food selection becomes particularly dangerous for pet specialty retailers when it is combined with the fact that more shoppers—particularly those in certain demographics—are increasingly focused on convenience. “When you’re talking about the Millennial generation, which is a big segment of consumers [for the pet industry], they’re all about convenience,” she says. “So, if they’re already at a store buying their groceries, and that store offers organic or grain-free pet food, why not buy it while they’re there, instead of driving to another store.”
According to Lange, the allure of convenience is also driving heightened competition from online retailers, such as Amazon.com and PetFlow.com.
Unfortunately for the big-boxes, especially PetSmart, efforts to differentiate their product mix from that of players in the grocery and mass channels have not been particularly successful. This includes an aggressive move toward private-label that some industry experts say has fallen flat. “What I’m hearing is that the brand strategy that PetSmart instituted a few years ago, which had them moving away from branded products and toward private-label in a bunch of areas, has backfired on them,” says Carol Frank, managing director at SDR Ventures, a Denver-based investment bank that counts the pet industry as one of its areas of expertise.
While Jack Drasner, president of sales and marketing firm PRISM Sales, doesn’t necessarily see PetSmart’s focus on private label as a failure—in one product category, he observed that PetSmart’s private-label entry outsold closest branded product by a margin of three to one—he does see potential dangers in eschewing popular and emerging pet brands. “Private label is a tricky line to walk,” he says.
“One of the potential pitfalls for the industry, as well as big-box stores, is limiting innovation to reach the shelves,” says Drasner. “Petco and PetSmart’s challenge is to keep the ‘special’ in pet specialty. They don’t want their stores to start looking like a grocery aisle.”
The move toward more private-label products can have another important effect that Drasner says may ultimately add to the challenges facing the big-box pet chains. “You have vendors who are seeing their products turned into a private-label at PetSmart, and it forces them, in a way, to go to [mass and grocery] with their branded products,” he explains. This obviously furthers those outside retailers’ access to a larger, more-premium selection in the pet category.
From his perspective, Picone has observed a number of brands, particularly in the pet food category, make the move out of Petco and PetSmart and into grocery and mass. He compares this trend to the channel dynamics that independent pet stores suffered a decade ago. “If you walked down the pet food aisle of Petco or PetSmart 10 years ago, you saw a lot of brands that you don’t see there today, because they have all shifted over to grocery,” he says. “So, there has been a deterioration of brands that they can carry.”
In effect, says Picone, “Grocery and mass is doing to Petco and PetSmart what the big-boxes did to neighborhood pet stores years ago.”
Adding fuel to the fire in Petco and PetSmart’s battle against outside retail channels is the fact that neither big-box chain has a pricing structure that can go head-to-head with players in grocery and mass, for example. As Jana Partners mentioned in its letter to the PetSmart board, a basket pricing survey that the investor commissioned revealed that the chain’s prices were anywhere from 15 to 35 percent higher than that of “key competitors.” And, as many industry experts point out, Petco’s pricing is no better. “Neither one is the low-price leader,” says Frank. “They require extremely high margins—in some cases as high as 60 to 70 percent.”
At the same time that they are facing increased pressure from outside retail channels looking to cash in on the pet care market, Petco and PetSmart officials are finding that other, smaller pet specialty retailers have become more formidable competitors over the past several years. While independent pet stores and regional chains have long had a competitive advantage in terms of providing a high level of customer service, technological advances have gone a long way in leveling the playing field for these retailers, which now enjoy efficiencies that were previously reserved for much bigger operations. Today’s mom-and-pop pet stores can order from suppliers electronically, manage the product mix based on up-to-the-minute sales performance, and reach target customers more effectively than ever.
“Technology allows me to do the metrics and analysis that just didn’t exist [for a business this size] 10 years ago,” says Picone.
Chuck Anderson, founder and CFO of the 28-store Chuck & Don’s chain, based in Mahtomedi, Minn., is another retailer who understands the important role that technology has played in the success of his business. “We have so many technical resources tied into our POS program,” he explains. “And if we had those resource from the beginning, we would have grown even faster.”
The rise of social media is also impacting competitive dynamics within the pet care market. “Social media is having such a large effect on shaping consumers’ shopping habits,” says Anderson, noting that marketing through channels such as Twitter and Facebook is a practice that can be just as effective for small independent and regional chains as it can for the big boxes, if not more so.
To Drasner, while technology has certainly played a big role in leveling the playing field for a diverse group of pet specialty retailers, a lot can be said about the quality of retail professionals utilizing that technology, as well. “There are just a lot more good business people operating these pet stores,” he says.
The quality of personnel operating independent pet stores and regional chains is not limited to the top of these businesses. While providing a high level of customer service is often taken for granted as a strength of these retail establishments, the importance of such service—and the vital role that store staff plays in delivering that service—cannot be overstated. Due, at least in part, to the fact that independent and regional chain retailers often have lower employee turnover than the big boxes, they are often staffed with associates that are far more knowledgeable and passionate about pets.
“The bigger you get, the harder it is to provide personal service,” points out Anderson, noting that delivering such service has been the key to Chuck & Don’s ability to compete with Petco and PetSmart in its markets, which include Colorado, Minnesota and Wisconsin.
To Picone, staffing pet stores with well-educated employees who can effectively communicate their knowledge to customers has become increasingly important, as shoppers have become more discerning about the type of care they provide for their pets. “Today’s pet shoppers definitely want more information,” he says. “And the big-boxes can’t keep up with an educated pet parent.”
Of course, going hand-in-hand with the high level of education and service that can be found at independent and regional chain retail outlets is a unique mix of best-in-class products that cannot be found in grocery, mass or even big-box pet specialty stores. This is an area in which Picone says that the independent channel is much better prepared than it was when Petco and PetSmart made their ascents to the top of the pet retail food chain. “Years ago, there were only a few brands that stood out and differentiated independents,” he says. “Today, there are so many brands that only sell to independents. That is important, because now when a brand moves [from the independent channel] into the big-boxes, there are plenty of others that can take their place.”
This is a point that is echoed by Drasner, who says that the current trend toward distributor consolidation in the pet specialty channel can serve to enhance smaller retailers’ access to products that will set them apart from the competition. “There are so many manufacturers that are willing to work with regional distributors and independent stores and chains, and they simply can’t and won’t work with national retailers.”