Investing in Successful Retailers

By Andrés Cardenal - July 12, 2012 | Tickers: AMZN, AAPL, COST, PETM, SHLD | 0 Comments

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They say that retail is dying, but that's not necessarily true. Many retailers are certainly going through extremely hard times, and it looks like some of them may be on their way to disappearance unless they find a way to turn things around. But at the same time, many other companies in retail are doing particularly well, and rewarding investors handsomely by applying the right strategies.

One kind of retailer which has gained a lot of traction in the current environment of uninspiring economic growth are those which focus on the lowest prices achievable, with Costco (NASDAQ: COST) being a notable example. Strong supply chain efficiencies and a dominant market position which gives it bargaining power over its suppliers have made Costco a tremendous competitor when it comes to pricing, and that has produced an annual increase in sales of more than 8% per year for this discount retailer.

Costco is by no means a dying company; quite on the contrary, it’s thriving thanks to its cost advantages.  The same can be said about online retailer Amazon (NASDAQ: AMZN) which has delivered an astonishing 35% annual increase in sales over the last five years. With an unbeatable cost structure and its tremendously aggressive competitive culture, Amazon is arguably the most disruptive force in the retail business over the last years.

Companies like Amazon and Costco have played a big role in the serious problems faced by traditional retailers like Sears (NASDAQ: SHLD), which has been battling with falling sales and declining profit margins for the last several years. But it would be a mistake to believe that Sears is in so much trouble due to low price competition exclusively.

Sears has used most of its cash flows for financial activities like share buybacks instead of taking care of its stores and providing a positive experience for its customers. A deteriorating service, combined with stiff competition from low price leaders, has put Sears in a weak competitive position, and its shareholders have suffered the consequences over time.

But low prices are not the only competitive strategy which is working in the current retail scenario, some companies have differentiated themselves through a superior customer experience, and that has been translated into tremendous commercial success. Apple (NASDAQ: AAPL) is perhaps the most noteworthy success case in the retail industry over the last years, and that's not related to cost advantages.

Apple is the company with the highest sales per square foot in the retail industry, with more than double the sales per square foot of the second performer, Tiffany. While Tiffany is above $3,000 per square foot and its closest competitors are below $2,000, Apple is showing an amazing record of more than $6,000 in sales per square foot.

 The company's retail operations are clearly benefiting from the tremendous success of its products, but Apple sells its devices through different channels, so customers could still buy Apple products by other venues if they wanted to. Apple stores, however, have many attractive features which explain their remarkable success.

Design, overall aesthetics and customer service are noticeable factors which make Apple stores a unique experience, and this differentiation is the biggest reason behind Apple's extraordinary success in the retail business.

Low prices are not the only competitive strategy which works in retail, companies which offer valuable traits to their customers can do really well in spite of the challenging economic environment. One company which is building a solid position in specialty retail is PetSmart (NASDAQ: PETM), the leading player in goods and services for all kind of pets.

Food, toys, apparel and even services like PetsHotels which provides boarding for dogs and personalized pet care are included in PetSmart´s varied offering. The industry has attractive growth prospects due to increasing pet ownership and rising expenditure levels per pet, and PetSmart is well positioned to capitalize on these opportunities.

Mass merchants don't have the same level of product diversity, and they are unlikely to devote the same square footage to compete with the company's service offerings. But one indisputable advantage PetSmart has over potential competitors is the personalized attention it provides to pets and their “parents,” like they say at PetSmart.

Company employees usually get quite familiar with the pets, which is a huge asset when it comes to relating with the animals and earning the trust of their owners. People and their pets usually come back to the same PetSmart store for purchases or all kind of products and services, and that makes the personal impression an irreplaceable competitive advantage.

PetSmart has delivered positive comparable store sales figures over the last years, even during the hardest of times, like the last recession, during which discretionary spending suffered strong setbacks in almost every segment. Although some of the products offered by PetSmart are available at mass merchants for lower prices, the company has done considerably well in a difficult environment for retailers due to its differentiated service and value added to its customers.

Retail is not dying; investors just need to be very careful when selecting companies in the industry. Either a strong price leadership or a high quality service can be the source of sustainable competitive advantages in the industry, and the biggest opportunities can sometimes be found in those sectors where hope is scarce.

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