Little. Yellow. Different.

Little. Yellow. Different.

Did you hear the one about the discount retailer based in the South that pruned its selections, cleaned up its stores, broadened its customer appeal, changed its logo, introduced private labels, emphasized food and succeeded? There's little doubt that the success of Dollar General author of all of the above changes and beneficiary of robust sales and margin improvements that have come along with them

Did you hear the one about the discount retailer based in the South that pruned its selections, cleaned up its stores, broadened its customer appeal, changed its logo, introduced private labels, emphasized food … and succeeded?

There's little doubt that the success of Dollar General [4] — author of all of the above changes and beneficiary of robust sales and margin improvements that have come along with them — has captured the attention of the retailing world. And perhaps no competitor has watched with any more frustration and envy than Wal-Mart Stores [5], which tried similar tactics on a similar customer base over a similar time period but has yet to see similar results.

“Wal-Mart is pushing all of its suppliers to try and understand how much business they are losing to Dollar General,” Dave Marcotte, director of retail insights at Kantar Retail, Cambridge, Mass., told SN. “They know they're losing business to that channel, but they don't know how much, and with Wal-Mart's business being what it is now, they're looking to plug any leak.”

While big discounters such as Wal-Mart are the likeliest victims of Dollar General's sales growth, they're not the only ones. The Goodlettsville, Tenn., discounter posted an annual same-store sales increase of 9.5% in fiscal 2009, trouncing slow-growing formats, including conventional supermarkets.

Observers attribute the company's recent success not only to America's appetite for value, but to a successful reinvention at the right moment under former Safeway executive Richard Dreiling [6], who took the helm shortly after the company's acquisition by the private equity firm KKR in 2007. That deal — which at the time drew criticism for its price — has turned out spectacularly for KKR, which last year spun a portion of the company back into the public markets.

After a few years of relative slow growth, Dollar General is currently in the midst of a new-store building spree that recently took it past the 9,000-store mark. Company officials were unavailable to comment for this article, citing a quiet period prior to second-quarter earnings. Dreiling, in remarks during Dollar General's most recent quarterly conference call in June, summed up the company this way: “We have made great progress in the first quarter of 2010, and we are optimistic about the rest of the year. Our customer is responding to the steps we've taken to improve our stores and our product offerings. All of our initiatives seem to be paying off.”

Transitioning the Business

The company known today as Dollar General was founded in 1939 as J.L. Turner & Son Wholesale. According to a company history, James Luther Turner was a poor Tennessee farm boy who twice failed at starting his own retail store before becoming a traveling salesman for a local grocery wholesaler. When the Great Depression hit, Turner and his son, Cal, began buying and liquidating general stores that had gone bankrupt.

Their third attempt at retail was a success, especially in 1955 when they opened their first store under the Dollar General banner in Springfield, Ky. The store offered no items costing more than $1, a then-novel concept soon applied to other stores in the Turners' burgeoning chain.

J.L. Turner died in 1964, and four years later the company he founded, doing $40 million in annual sales, was rechristened a public corporation named Dollar General. Cal Turner served as president through 1977 and his son, Cal Turner Jr., ran the company until 2002. The Turner family maintained a large stake in the company until KKR purchased it in a $7.3 billion buyout in 2007.

Dollar General at the time was overcoming some internal issues. The company endured an accounting scandal in 2002, then a restructuring announced in 2006 forced the closure of hundreds of stores and a costly inventory clearance. And although the channel was recognized for its potential to grow, and Dollar General maintained a pace of growing same-store sales, it suffered from a stigma — some deserved — of poor-quality merchandise and dirty stores, observers said. Dreiling, in remarks shortly after taking the reins as CEO, said Dollar General had recently been guilty of “aggressive store expansion without operating discipline” and of employing merchandising strategy “not supported by sufficient research and analysis.”

His plan for recovery focused on four goals: driving productive sales, increasing gross margins, leveraging process improvements and strengthening its culture. The company remains committed to these priorities today.

“They've gone back and looked at everything they do to see whether it was done professionally and efficiently,” Meredith Adler, an analyst for Barclays Capital, New York, told SN.

Operator at the Helm

In more than 30 years running the grocery businesses for Vons and Safeway, Dreiling had a reputation as a particularly good operator, observers said. “In conversation, he's told me he always liked the operations side of it,” Bill Bishop, chairman of Willard Bishop, Barrington, Ill., told SN in a recent interview. “And they [Dollar General] are benefiting from an operator at the helm, as opposed to a financial guy at the helm, or a strategist at the helm, or even a merchant at the helm. With an operator, you concentrate on what makes things work and what drives efficiency store by store.

“One of the things that worked really well for them was the alignment of what the retail vision is from the CEO's office to the store,” Bishop continued. “It allows them to execute the pretty powerful imagery they have as the biggest player in a pretty hot area of retailing.”

A large part of that vision — an offshoot of the goal of driving productive sales — was an effort to improve not only the selections in the store but the look and feel of the store itself. A new logo and decor package created by Interbrand Design Forum, Dayton, Ohio, helped modernize Dollar General's longtime brand attributes of friendliness and value, while also embracing a wider shopping audience, Ryan Brazelton, senior creative director at Interbrand, explained.

“I think it was timely of them to recognize an opportunity to extend an invitation out to those who might not have viewed the dollar channel as a viable or smart way to meet their basic needs,” Brazelton said. “The research they had done showed their customers felt they lacked in some key areas and there were negative perceptions about the channel.

“This was a real opportunity to transform the brand, not just into its best self but into a new entity that would help define the channel again,” he added.

Interbrand contributed much of the company's graphic identity behind a new logo and interior signs bringing a fresh look to new and refurbished stores.

The pieces are dominated by yellow and black — colors people associated with value retail even if they couldn't identify them as Dollar General's colors, Brazelton noted. That tradition emerged from a legacy logo created primarily to make its store signs — often atop poles in odd locations — easy to see from a distance.

“What we tried to do was take that equity and put a story to it,” Brazelton said. “And so we took that carrier, the box that wordmark was in, and turned it into the shape of a stretched dollar, then put a new wordmark in there that's friendlier and easy to read, while still keeping the quirkiness and friendliness the brand has always had. Consumers have really responded.”

Other efforts were intended to turn negative perceptions to positive ones, including positioning Dollar General's small store size as a virtue by reminding customers of the store's convenience and short shopping trips. “It's a big idea, but they'd never told that story,” Brazelton said. “There are a lot of things the company has always done that have been very consumer-centric that they've never gotten credit for.”

The company's message to consumers today — “Save time. Save money. Every day.” — leads with a prominent reminder of its convenience.

More Productivity

The new look of the stores is part of a more productive package inside. Dollar General is raising shelf heights to a uniform 78 inches to get more items in the store, and is implementing more consistent space planning, officials said. Category management processes have been improved so that less productive items have been pared from selections and better sellers have been added — a powerful tool for a limited-assortment retailer and one of several levers of gross margin improvement utilized by the company.

Improved sourcing, supply chain improvements and a new emphasis on private brands are others. The chain since 2008 has introduced a variety of private brands in two tiers, including Clover Valley foods, DG Baby, EverPet, DG Everyday, along with value labels DG Value and EverPet Basics. Company officials said private-brand penetration among consumables was 21.7% during the first quarter, an increase of 110 basis points from the same period in 2009, and comparable to the figures at supermarket chains.

Bishop called supply chain improvements a “secret sauce” to Dollar General's recent success. “Even though their reason to take a bow for the most part is in the stores, they've done a very good job behind the scenes, improving the supply chain,” he said.

These efforts have resulted in escalating product margins even as the company's primary consumers continue to struggle — and competitors in other channels take margin hits to draw more shoppers. Gross profit as a percentage of sales was 32.1% in the first quarter, an increase of 136 basis points since 2009. Better-looking stores and improved merchandise have kept middle-income shoppers coming to Dollar General even as the recession has eased for them, observers noted.

“One of the reasons the sales surge has continued after the recession is that people are getting used to going there first and they figure, ‘If it's not there, well, OK, we'll find it somewhere else,’” Marcotte said. “Dollar General's strategy has been pretty aggressive in getting that kind of shopper, especially for seasonal events.”

Process improvements at Dollar General range from a focus on safety to reduce worker accidents and compensation claims to a new effort to sell its cardboard waste. “We are committed as an organization to extract costs that do not affect the customer experience,” Dreiling said.

Adler of Barclays Capital noted that Dollar General's focus on improving its efficiency and sophistication came at the right time to serve a low-income customer base and an economy poised to send them new shoppers.

“Their appeal is going to continue to be very strong,” she said. “The economy will recover to some extent, but six or seven years ago, when I picked up this [value retail] group, if you looked at the demographic data you saw the customer was getting poorer. And if you took out the phenomenon of the ‘rich getting richer,’ you'd find there were lots and lots of people who need what the dollar store provides.”

This vehicle is beating large discounters like Wal-Mart in part because of advantages of more-convenient locations and a focused merchandise selection that keeps shoppers away from things they cannot afford, Adler said.

“The advantage Dollar General has over Wal-Mart is convenience and also less temptation,” she said. “Wal-Mart has great values too, but if you are on a strict budget you probably don't want to go [to Wal-Mart] too often, especially if you have kids.”

Marcotte noted that Dollar General in some ways owes its success to Wal-Mart for having “sucked retail energy out of small towns,” and allowing Dollar General to cheaply occupy the role — and sometimes the physical space — of “Main Street” retailers that couldn't survive Wal-Mart's arrival.

“Whether these were ever vibrant downtowns, you could always add a Dollar General to them, and in that sense Wal-Mart helped build their business,” Marcotte said. He noted that like Wal-Mart, Dollar General is strongest in the South and considerably less strong in areas like the Pacific Northwest. “Their footprints are nearly the same.”

“I know from my conversations with folks at Wal-Mart that the dollar store and limited-assortment store are perplexing,” added Bishop. “And when you talk about a high-productivity large store, the efficiencies of scale, their supply chain and their operations and their assortment, it should give them some hands-down advantages. But when the consumer starts moving across different channels, it's tough.”

Approaching 10,000

Asked by an analyst to address the sustainability of margin improvements at Dollar General, Dreiling admitted that “sooner or later the improvement in margin is going to moderate,” but emphasized that Dollar General's work to improve sourcing, sell private brands and do category management are revolutionary changes in the sophistication of the dollar store. And he noted that profit cushion will give the retailer plenty of ammunition to fight for customers on price if and when other channels challenge for its shoppers.

As Dollar General approaches 10,000 stores and moves to populate the 15 states where it currently does not do business, observers said keeping an eye on its core customer and its core retail strategy will be key.

“If I were an investor in Dollar General, I'd be concerned if they went out and bought somebody as a means to grow. The organic growth they are doing now is good stuff. But if they went and bought a Hardee's or a Rite Aid, I might get worried,” Marcotte said. On the other hand, the value apparel retailer Rainbow might make a good match, especially if Dollar General makes improvements in the apparel business it is seeking.

Bishop said he would be concerned about the necessity to offer local products. “The challenge for them is, how do you improve your local offering without losing your efficiency? This requires some systems and methods and adjusting, and it's hard for a low-cost operator with a proven model to make such adjustments.” Bishop also noted that non-retail alternatives — such as subsidized community agriculture programs now taking off in some cities — could wear away at its core customers.

Keeping an eye on its core shopper as it expands appeal should also be a challenge for Dollar General, said Adler, noting that Wal-Mart's recent shift to a softer feel probably cost it some of its value equity.

“They have to strike a balance in terms of the store design and format,” said Adler. “Making sure the sites are attractive to the middle-income consumer but don't alienate the poor customer. At some level there has to be a concern that if a store is too neat and pretty it will scare off the core customer.”

Dollar General sees more opportunity ahead, including its 10,000th store, which at its current pace could arrive as soon as next year. But the number that concerns Dollar General isn't 10,000 but $843 billion: That's its estimate of the basic consumer packaged goods market. “Our current share of the $843 billion basic consumer packaged goods market is only 1.2%, which, when coupled with our attractive value and convenience proposition, we believe provides substantial opportunity for growth.”