Family Dollar Case Write Up

Dollar General/Family Dollar Case Write Up

Industry Analysis

From the Five Forces Model, we determined that rivalry among existing firms and the threat of substitute products are very high in this industry. This is mainly due to the low consumer loyalty that is associated with undifferentiated products. Similar products with slight variation in price, quantity and store format also yield low switching costs which increases the threat of substitute products. Demand is driven by consumer spending, particularly among less affluent consumers, as most companies target the lower- to middle-income demographic. In addition to competing with other dollar stores, industry players also compete with operators in the Warehouse Clubs & Supercenters, the Department Stores industry, and the E-Commerce & Online Auctions industry. The threat of new entrants, the bargaining power of customers, and the bargaining power of suppliers are all low in the discount variety industry. The low threat of new entrants is due to the preexisting relationships that must exist with the suppliers. The threat of bargaining power of customers and suppliers are low because the products are undifferentiated. Also, because the prices are already so low, there is no need to bargain for a lower price.  The profitability of individual companies depends on their ability to effectively locate stores and to maximize their revenue per square foot. Large companies have advantages in purchasing and in negotiating lease arrangements. Small companies can compete effectively by locating in a previously untapped market. Because the four largest companies account for about 80% of sales, the US industry is highly concentrated, and prospective operators planning to enter this industry may encounter strong competition from incumbent enterprises.

These external competitors have pressured industry operators and encouraged industry consolidation. From investment perspective, mergers and acquisitions will allow operators to take advantage of economies of scale more easily; these expanding operators can leverage their size to garner favorable supply chain contracts and pass cost savings on to consumers, which helps maintain a customer base. The Dollar Stores industry has transitioned from a growth phase to a mature phase in its life cycle. Signs of this transition have already begun to show, particularly in the form of consolidation. The consolidation was a natural consequence of trends emerging over the past five years, whereby industry operators were unable to sustain growth considering fierce internal and external competition. As competition from big-box retailers and supercenters continues over the next few years, the industry will continue to consolidate; M&A activity is a clear indicator of a mature industry.

Financial Performance

Dollar Tree (DT) and Dollar General (DG) are clearly out performing Family Dollar (FD) on almost every financial metric.  FD’s performance has dropped significantly over the last two years (2014 and 2015), but before this recent decline the company was performing in line with the industry.   Both DT and DG’s 5-year revenue CAGR is about 10% where FD’s is only around 6%.  Furthermore, FD’s profit margin has dramatically dropped from 4.5% in 2011 to a measly 2.2% in 2015, thus dropping its return on equity from 31.0% to 13.2% over that same period.   After conducting a DuPont analysis it is clear that DT and FD’s strategies are aligned. As of 2015, both companies have more financial leverage and a greater asset turnover than DG, but DT is able to sell products at a higher margin thus increasing its ROE to around 40% which is well above DG’s ROE of about 20%.  Please see the appendix for all calculations.