It’s a dogfight at America’s pet stores as COVID-19 upends the $96 billion industry

The fancy-food push reflects the cultural shift that has upended the $95.7 billion U.S. pet products industry in recent years. The “humanization” of pets has become a mantra repeated endlessly by industry insiders: One pet-food executive used the word 32 times in a 20-minute interview with Fortune. It’s shorthand for Americans’ growing tendency to treat their pets like family members. “Thirty years ago, the pet was on the porch, and now it’s on the bed,” says Sumit Singh, the 40-year-old CEO of online pet-supply juggernaut Chewy, of which PetSmart is the majority shareholder. Tellingly, every one of the more than two dozen analysts and executives Fortune spoke with for this story referred to animal custodians not as “owners” but as “pet parents.”

That paradigm shift has set off a cascade of changes in how people shop, forcing retailers and manufacturers alike to reinvent themselves. And in an evolution that mirrors human-retail trends, that reinvention has been intrinsically linked to a “premiumization” of their products. That means more upscale offerings—think quinoa in the cat chow and orthopedic dog beds. But it has flowed down to the middle of the market, too, with some retailers purging GMO-based ingredients entirely from their food shelves and offering services like dog-walking and “pet wellness.”

The two privately held superstores have begun to get the balance right. Petco, with annual revenue of about $4.5 billion, has bet successfully on higher-end food and a big reinvention of its stores; the company has recorded six consecutive quarters of comparable sales growth. PetSmart, the industry leader with an estimated $7.4 billion in sales last year, has brought to a near-halt a long sales decline by upping its investments in services like “pet hotels,” doggy day care—complete with story hour—and in-store veterinary clinics.

The change in tactics has enabled the dog-and-cat duopoly to hold their own against big-box mastiffs Walmart and Target, which have also upgraded their pet food and supplies and vastly expanded the assortment they stock. The pet specialists have gotten stronger at e-commerce, too. Petco was getting about 10% of sales online right before COVID-19, and that has shot up since the pandemic kicked in. And Chewy.com, which PetSmart bought in 2017 for $3.3 billion, has relied on “high touch” personalized marketing, 24-hour-a-day customer service including advice on products, and algorithmic upselling to become the industry’s biggest online player, with $4.8 billion in sales in 2019—beating even Amazon.com in the pet category.

Thirty years ago, the pet was on the porch, and now it’s on the bed.

Chewy CEO Sumit Singh

The urgent question now facing pet retailers is whether this momentum can survive the shock of the coronavirus. Historically, pet products have been business’s closest thing to a recession-proof industry, bolstered by the obsessiveness Americans have for animals: 77 million U.S. households have at least one dog, and 58 million are run by at least one cat, among countless others that host bearded dragons, budgies, and butterfly fish. The sector’s sales never dipped during the Great Recession and have grown an average of 6% a year over the past decade. But the industry most likely won’t get off that easily this time. Research firm Packaged Facts expects U.S. pet retail sales to fall 17% in 2020, to $78.5 billion; food sales will likely still grow, but services like boarding, grooming, and non-urgent vet services are already dropping off badly.

So far pet stores—big boxes and neighborhood shops alike—have been deemed essential services and allowed to stay open by the authorities. The kinds of services that have drawn customers into stores, like grooming and training, have all but shut down, but Petco and PetSmart have been able to mitigate the pain by offering curbside pickup for orders placed online. What’s more, the spring’s drastic lockdowns led to a surge in pet adoptions—and consequently, Chewy, PetSmart, and Petco all saw sales soar initially as customers stocked up. Petco says that even sales of its fresh and frozen gourmand JustFoodForDogs meals have risen since lockdowns began.

Still, a prolonged downturn could endanger the link between Americans’ love of animals and their ability to pamper them. “We will probably see people looking for more value in the products they purchase,” says Steve King, CEO of the American Pet Products Association.

And if more “parents” decide that pets don’t need much, that could force pet retailers to adapt yet again.

Petco was founded in 1965 as UPCO, a mail-order vet-supply business based in San Diego. By the 1980s it had become a national retailer. Another pet chain with big ambitions got off the ground in Phoenix in the 1980s, eventually settling on the name PetsMart in 1989. (A few years later, to avoid association with the unrelated, faltering Kmart chain, the company redeployed its capital, so to speak, becoming PetSmart.) PetSmart now has about 1,660 stores.

Over the years, both chains opened up their big boxes across the country. By gradually adding services like grooming and boarding, particularly in PetSmart’s case, they gained a stranglehold on pet retail. Over the past two decades, their market share and strong cash flow attracted the attention of private equity firms, which acquired them in leveraged buyouts. In 2015, PetSmart, which had been a Fortune 500 company since 2008, was taken private by BC Partners for $8.7 billion. And Petco bounced between private equity firms and the public markets before eventually being bought by its current owners, CVC Capital Partners and a Canadian pension fund, in 2016.

Like other brick-and-mortar retailers, the big incumbents grew complacent. Ownership focused more on cost-cutting and reducing debt than on making improvements. “They thought they were well protected by their in-store experiences and services,” says Moody’s analyst Mickey Chadha, who evaluates both companies’ mammoth debt loads.

Competitors began to bridge the giants’ protections in earnest over the past decade. Big foodmakers like Purina, Mars, and General Mills weakened those chains’ duopoly and started selling more of their better products at Walmart and Target too, tired of chronic drops in pet-store traffic. Amazon also made a dent: While conventional wisdom in the industry had long held that shipping heavy bags of dog food or kitty litter made pet e-commerce unworkable, the Seattle slayer began stealing market share for “hard” goods like leashes, bowls, and cat trees as well as food. (For more, see “Why the pet industry hopes Americans will start treating their cats more like dogs.”)

But perhaps the biggest shock to the system was the rise of Chewy.com, which launched in 2011. Chewy became an online pet store by accident: Ryan Cohen, its Montreal-born cofounder, had initially wanted to launch an online jewelry store but then realized that Petco and PetSmart had left the e-commerce market for pets up for grabs. To compete with the much bigger Amazon, Chewy focused on relating to customers as fellow pet parents. That included touches like randomly sending customers drawings of their pet made by one of 1,500 artists with whom Chewy contracted. “The pet portrait was to show our customers that we’re not Amazon, this isn’t a machine. You’re dealing with pet lovers,” says Cohen. Today, new pet owners get a congratulations note as if they’d had a baby, and owners who lose a pet may get condolence flowers. (Cohen no longer has a role with Chewy, but the company’s first big private-label food brand, Tylee’s, was named for his dog.)

Chewy boosted its growth by mastering automatic replenishment of staples like food and litter with “set it and forget it” service, which now generates 70% of its sales. As the dates for new autofill orders approach, Chewy’s tech enables it to suggest add-ons with which owners might be willing to experiment, says CEO Singh—particularly pet treats, now a $7 billion market in the U.S.

The jolt of tougher competition finally awoke the two pet super-chains. If they wanted to keep their huge store networks from becoming liabilities, they’d need to make a stronger case to shoppers—with a wider array of services and higher-quality “store brands” that other big retailers didn’t have, all under one roof.

“We are sprinting away from ‘commodity-ville,’ towards services and products you can only get at Petco,” says Ron Coughlin, chief executive since 2018. A visit to Coughlin’s office at headquarters in Rancho Bernardo, Calif., brings a reminder that Coughlin, 53, is a pet parent too. Coughlin’s 11-year-old yellow Lab, Yummy, bounds around the room and has no reservations about interrupting a conversation to demand that his owner’s interviewer provide head scratches.

A Petco store in nearby Escondido is one of 300 in the 1,500-store chain so far to get the full-on remodeling treatment that exemplifies the chain’s hoped-for transformation. In the food aisles, if the vibe a few years ago was Albertsons for Kitties and Doggies, now it’s more like Whole Foods. There are homey touches like wood shelf panels and signage, a Treatery stand for baked goods for dogs, and a station where pet owners can get nutritional advice that involves Petco’s premium WholeHearted food brand.

Just as striking are the spacious areas for services like grooming, boarding, and training. Some 40% of the space in many remodeled Petcos is devoted to services, which generate more than 10% of sales and are growing fast. At the Escondido store, pet owners can bring their dog in and wash it themselves for $15. That’s a draw for apartment-dwelling customers, particularly young ones, who don’t have backyards and want to avoid a mess in their own bathrooms. Petco is also rolling out vet clinics in earnest; it’s added them to 90 stores so far, with another 50 planned this year.

PetSmart was big on services before Petco jumped into that dogfight, and it’s taking steps of its own to maintain its head start. Its PetsHotel boarding facilities, which launched in the 2000s, now operate in 207 stores and eight stand-alone locations; prices start at $35 a night for boarding. They’ve long offered features like hypoallergenic beds and indoor tracks for long walks; now PetSmart offers luxury “suites,” where pets can sleep apart from other animals and get individual walks and playtime.

PetSmart is also overhauling its Doggie Day Camp daytime boarding. The company brought in animal behaviorists and even consulted human childcare development specialists to see what activities it could add, explains J.K. Symancyk, PetSmart’s 48-year-old CEO. “What you have is a structured day just like you would in day care,” he says. That includes story-reading time at 2 p.m., with a reader seated in the center of a room full of dogs. Some 70% of the dogs typically pay rapt attention, Symancyk says, but he admits, “There’s always a few who don’t listen and want to do their own thing.”

Analysts credit store overhauls like these with halting the erosion of the megachains’ share in a very fragmented market. Petco and PetSmart now account for about 18% of retail sales, on par with the faster-growing online retailers, and a hair behind mass merchandise stores like Walmart. (Supermarkets and small independent stores account for most of the rest.)

We are sprinting away from ‘commodity-ville,’ towards services and products you can only get at Petco.

Petco CEO Ron Coughlin

The Big Two have also finally become real contenders in e-commerce—a trend that the coronavirus, with the imperative it creates for online ordering, has helped accelerate. Coughlin landed the Petco CEO gig in part because of his tech background: He was previously at HP, where he ran the “personal systems” business selling PCs and tablets.

PetSmart, as mentioned, owns Chewy—but its relationship with e-commerce is more complicated. Beyond selling some of each other’s brands, Chewy and PetSmart have remained strictly separate as business units, and PetSmart gets only about 4% of sales online. Some in the industry see PetSmart’s acquisition of Chewy as less of an e-commerce strategy and more of a financial-management tactic.

PetSmart took Chewy public in 2019. Because the companies had stayed largely separate, notes Moody’s analyst Chadha, Chewy could “get a loftier e-commerce valuation, and not a brick-and-mortar valuation.” Indeed, the IPO was a bonanza: Chewy’s market cap on the offering date was $14.3 billion, or nearly five times what PetSmart paid for it. And PetSmart used the proceeds to pay down some of its huge debt load. (Wall Street surmises that PetSmart will continue to offload its estimated 67% remaining stake over time.)

PetSmart’s Symancyk, who sits on Chewy’s board and owns 2% of the stock, insists that financial strategy aside, separation is “what’s best for both companies,” adding that owning Chewy has helped PetSmart improve its own e-commerce, especially through better data analytics. There’s also a cultural consideration in play: After the 2017 acquisition, there was a backlash among Chewy customers who were fearful that PetSmart would impose a big-box, big-corporation mindset on the startup. Letting Chewy run its own doghouse, in other words, might keep its customers loyal.

The premium pet-food phenomenon was energized, more than a decade ago, by a pet-food tragedy. In 2007, tens of thousands of pets were sickened from food that was contaminated with melamine, a chemical used in making plastics. The resulting recall affected 180 brands. Pet owners were already nervous about “feed grade” food, which isn’t regulated by the Food and Drug Administration and is often produced abroad. Pet food with fresh ingredients and raw meat—generally made in the U.S. and often locally sourced—underwent a boom.

For a while food prices and margins rose, luring dozens of new players into the market. Ultra-premium offerings like the venison in the Petco kitchen in Union Square still represent only a small sliver of the premium end of the business, but the broader “natural food” category became huge. At the apex of the gold rush, food behemoth General Mills bought natural-food maker Blue Buffalo in 2018 for $8 billion, still the largest deal ever in the pet industry. (For more, see “10 big business deals that are changing the pet industry.”)

More recently, the flood of new competition, including new brands from incumbents, has put downward pressure on prices. The premium market also wobbled in 2018 after the FDA said there could be a connection between grain-free diets—a large portion of the “healthy” pet food market—and dilated cardiomyopathy, a kind of heart disease, in dogs. Still, despite those setbacks and the category’s diminishing profitability, most industry analysts still see premium food as a market that even a global economic crisis won’t dent. And if the downturn persists and leads some food shoppers to trade down, premium store brands like Petco’s WholeHearted could pick up the slack. It helps that, from an owner’s perspective, pets are creatures of habit on the food front. “They have a way of letting you know if they’re displeased,” says David Sprinkle, analyst at Packaged Facts. 

The big pet chains are doing their part to keep consumers focused on the healthfulness of food. In May 2019, in a throw-down-the-gauntlet move, Petco stopped selling any food that contained artificial colors and other ingredients. It ditched the standard cat food Fancy Feast, one of its top-selling products, and nudged Nestlé Purina Pet Care to fast-track its Fancy Feast Gourmet Naturals to meet the chain’s new requirements. Mars, now the largest pet-food maker globally after a series of big acquisitions, has tweaked its own offerings with health in mind: Its Nutro food line, for example, now contains no GMOs, and Mars says it’s the first GMO-free brand sold at mass retailers.

These changes by the big food manufacturers show not only the staying power of healthier pet food, but the clout that Petco and PetSmart still wield. General Mills, for example, still gets 36% of its pet food sales at PetSmart and another 14% at Petco. Last summer, it launched a super-premium offshoot of Buffalo Blue, sold at those chains and Chewy only, called Carnivora. A 22-pound bag of grain-free adult dog food, made of 90% animal meat, cartilage, and nutrient-rich organs, can go for $99.99—easily more than twice a typical meat-and-grain dry food brand can cost.

At the same time, some of the manufacturers see a ceiling on humanization; they acknowledge that pet owners may often project their own food fads onto house pets. “What pets need is very different from what humans need,” notes Tracey Massey, global president of Mars Pet Nutrition, whose portfolio includes such big food brands as Royal Canin, Pedigree, and Whiskas.

Yummy, Ron Coughlin’s dog, had his cancer surgery last year at a full-service veterinary clinic. But he gets follow-up appointments, annual checkups, and other services at Thrive, Petco’s in-store clinic. Yummy isn’t an unbiased consumer—he’s best friends with the CEO, after all—but major pet retailers are hoping more American pets will follow his example. Humanization shapes consumers’ decisions about pet health just as much as it does their spending on food and toys—and Petco, PetSmart, and their competitors believe that could make in-store vet services a business that’s just as recession-proof.

Packaged Facts estimated in November (pre-pandemic) that spending on pet medication, which reached $9 billion in 2018, would increase by 33% by 2022. The embrace of pet health care insurance, still a niche product, reflects and reinforces that trend: Some 28% of dog owners and 22% of cat servants have some sort of medical coverage for their pet, building a market expected to hit $2 billion by 2024. There’s also evidence that shoppers aren’t especially price-sensitive about veterinary care—an important point considering that profit margins on both food and other pet supplies have declined over the past decade, according to a recent report by AlixPartners.

Trends like these are driving Petco’s new foray into vet clinics. (It also operates PetCoach, a web consultation service it bought three years ago.)  PetSmart has offered in-store vet clinics for decades, and now has them in more than half its stores—about 880 in all. But the bigger chain’s vet business itself is transition: PetSmart has hosted clinics under the Banfield Pet Hospital brand name in many of its stores since 1994, and collects rent, but it has sold off much of its stake in that business to Mars in recent years. Now PetSmart is recruiting independent vets to fill unused space at many of its stores; it also recently expanded its partnership with ShotVet, a mobile vaccination service.

There’s an e-commerce dimension to the health care push, too. Pre-pandemic, about 15% of pet medications were sold online. Chewy has a burgeoning online pet pharmacy business that it launched in 2018 and is pushing into services like basic online veterinary “telemedicine” consultations—a boon at a time when people are sheltering in place. Chewy’s knack for data-driven recommendations to customers can come in handy in vet services too. “We want data to get so robust, they can remind you of vet visits [and] suggest vets in your area,” says Chewy CEO Singh. “We can demand-generate for veterinarians,” while generating referral fees for the website in return.

The chains’ focus on vet clinics extends beyond traditional disease treatment and annual checkups. They’re also pivoting toward “wellness,” recognizing that matters like weight control and pet anxiety are becoming bigger issues for pet owners. A wellness focus could also spin off new products. PetSmart’s Symancyk thinks the near future could bring the rise of offerings like beverages laden with electrolytes—think Gatorade for dogs. Industry analysts expect meal plans and special-needs diets for pets to take off. On the tech side, wearables like collars that monitor how much a cat is moving—a feline Fitbit of sorts—are emerging as a promising area.

PetSmart and Petco are not the only ones to see a veterinary opportunity, of course. Walmart is opening vet clinics at 1,000 stores by 2023 by leasing space to clinic operators; it has also beefed up its online veterinary pharmacy. And Tractor Supply, a retailer with a major pet-supply presence, has pop-up vet clinics at some stores (though those are currently closed because of COVID-19). “That’s the nature of being in an industry that’s growing: A lot of people are going to come into it,” Symancyk says.

Then again, the crowding into pet health care has a particularly poignant subtext to it in the current moment. At a time when people are concerned about their own health and each other’s health as never before, there’s no more profound way to humanize a pet than to fret over its medical well-being.