Dollar Tree's acquisition of Family Dollar Stores will create a larger rival to battle Wal-Mart Stores, Dollar General and others that are fighting for the disposable income of those that have the least to spend on food and other consumer products.
The $8.5 billion merger will join two of the largest discount-focused retail chains, with annual sales exceeding $18 billion and more than 13,000 stores across 48 states and five Canadian provinces. Dollar Tree (dltr) and Family Dollar (fdo) executives touted the benefits of the deal, saying the discount space is in a sweet spot in the retail sector.
"Industry trends and outlook are positive for the combined businesses, with low and middle income customers continuing to look for ways to balance their budgets and stretch their dollars, the discount retail segment is vibrant and expected to grow in relevance," Dollar Tree Chief Executive Bob Sasser told analysts during a conference call.
All three of the major discount retail companies (Dollar General (dg) is the largest of the trio) have reported consistent sales growth in the years since the Great Recession, bolstered by growth at existing stores as well as the addition of new stores. But same-store sales growth in their latest fiscal years ranged between 2.4% and 3.3%, the lowest those chains have reported the past five years.
What's the problem? Well, discount retailers often cater to many lower-income shoppers that have been stung by flat wages, higher payroll taxes and also cuts to Food Stamp programs. Fed Chair Janet Yellen earlier this year said that while the labor market has improved, the share of the labor force that has remained unemployed for longer than six months and those working part time that would prefer to work full time are at historically high levels. Those macroeconomic challenges appear to be hurting a number of retailers exposed to lower-income consumers, such as Dunkin' Brands (dnkn) and McDonald's (mcd).
"The consumer, particularly at the lower end, is in a tough spot," Dunkin' Brands' Chairman and Chief Executive Nigel Travis said last week.
Frugal shoppers is just one problem discount chains face. Their success has also courted competition from the world's largest retailer, Wal-Mart (wmt), which has opened more smaller-format stores. The retailing behemoth has seen strong results from those locations, which more directly compete with discount chains and grocery stores.
Wal-Mart has opened 201 of those smaller stores over the past two fiscal years after opening only 34 in the prior three years. Wal-Mart's "Neighborhood markets" are performing well: same-store sales rose about 5% in the latest quarter, with traffic up about 4%. And Wal-Mart's strategy in the discount retailing space could see a shakeup, depending on how retail veteran Greg Foran intends to run the U.S. business when he takes over the reins next month.
Some observers say Wal-Mart and the discount chains should consider changing their branding strategy, and how they try to court consumers.
"The question for Family Dollar and Dollar Tree is 'What’s the extra?'" said Russ Meyer, global director at branding and consulting firm Siegel+Gale. Meyer says the discount chains and Wal-Mart often target their shoppers by promising low prices and convenient locations, but consumers of all income brackets are motivated by other factors as well.
Dollar Tree's Sasser sees benefits in controlling two brands that target different audiences and utilize different pricing strategies. Dollar Tree sells everything for $1 or less and targets a broad range of middle-income Americans in suburban markets, while Family Dollar mostly caters to lower-income households in urban areas and charges multiple prices for its products.
"There is a lot of power in having both brands to choose from to serve the customer," Sasser said. "Everybody likes a value."