Why GNC Isn't Scared of Amazon

Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Amazon.com (NASDAQ: AMZN) is the bane of any company in retail. Those smiley-faced boxes showing up on everyone's door step have put frowny-faces on many retail executives. Customers continually turn to the low-margin retailer looking for the lowest prices available. As more and more items find their ways into Amazon's warehouses and their digital shelves, companies are losing sales and struggling to fight back. Recently, customers have seen Amazon bulking up with GNC (NYSE: GNC) products. Will that make GNC the next retailer to suffer at Amazon's hands?

Product exclusivity

Exclusive and premium products have been GNC’s strategy for years. It consistently rolls out products from its own labs, and signs exclusive contracts to produce new products from third parties. However, the growth in GNC, particularly its franchising segment, has disrupted this exclusivity.

William Blair analyst Mark Miller recently took a random sample of 100 items sold at GNC stores. Of the 100, weightlifters and health-enthusiasts can buy 84 on Amazon.com. That’s a stark increase from the 67 Miller found a year ago. Comparatively, Amazon offers approximately 72% of the same merchandise as Best Buy, and most investors are aware of that company’s struggles with respect to Amazon.

By franchising its stores, GNC has opened up its products to the will of franchisees. Many of these franchisees have elected to use Amazon to distribute the GNC branded products, offering them at discounted prices compared to those found in-store. On average, the items sold for a 20% discount through Amazon, according to Miller.

The (not-so) secret weapon
GNC’s customer rewards program is one of the best in the retail industry. The Gold Card – which nearly 6 million customers pay $15 a year for – entitles members to a 20% discount on their purchases in the first week of every month. Interestingly, this is the same as the average discount on Amazon. Franchisees must figure that with the growth in Gold Card membership, they might as well sell items on Amazon for the Gold Card price.

Recently, GNC started making changes to the Gold Card membership experience. One of the biggest complaints from members was that they were only able to gain the benefits of Gold Card membership for one week out of every month. In response, GNC started testing everyday discounts to members in select markets starting in 2010.

In every market where GNC rolled out the new membership program, the results are the same: Margins take an initial hit, as expected. After about three to four months, stores cross the margin dollar neutral line. Then they accelerate quickly due to the increased amount of traffic and transactions. The changes generate significant increases in revenue, traffic, and gross margin dollars.

GNC will continue rolling out the new program to new markets in 2013. The structured rollout dissipates the impact on margins for the company’s retail segment. The price parity with Amazon gives customers less incentive to use the online retailer, and more impetus to talk to extremely knowledgeable in-store staff members or using GNC’s own website. Furthermore, the increase in Gold Card members gives GNC more insight into customers’ behaviors and the products they want, producing a pipeline for new products.

Why don’t they just stop the franchisees?

If the new Gold Card membership plan fails to mitigate the effects of Amazon.com sales of “exclusive” GNC products, perhaps GNC will take more drastic measures against franchisees. So far, however, there hasn’t been much noticeable negative impact on GNC’s finances. Gross margin increased to 38.3% in 2012 from 36.4% in 2011. Additionally, franchise sales grew from 16.2% of total revenues in 2011 to 16.8% in 2012, giving no signs of uncontrollable Amazonian cannibalization.

The continued growth in company-owned retail has undoubtedly dulled any effect of “rogue franchisees.” Meanwhile, the growth in franchising is an easy and effective way to increase brand identity, especially abroad. Cutting off franchisees from Amazon may slow the growth of the franchise segment, so until there are clear negative affects the avenue ought to remain open.

Of course, this is a weapon GNC management can hold in its back pocket. The company ultimately controls the distribution of its products, and it’s control that’s led the company to fantastic results in the past. GNC appears well positioned to fend off Amazon with its slew of premium if not exclusive products, and I see no reason why the stock won’t continue higher after another fantastic expectation-beating quarter. 

adamlevy owns shares of Amazon.com. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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