(This post is long and may not be very interesting to you. This is not an actionable idea.)
Lately I’ve been trying to learn more about the retail industry. Two things about Dollarama struck me:
- Its returns on capital are very high. My 2013 post on dollar stores put Dollarama’s return on capital at around 57.8%, dramatically better than all of its dollar store peers.
- Dollarama is a technology backwater. Dollarama did not fully implement a point-of-sale system until 2011.
Dollarama has higher returns on capital than most other retailers out there, yet it’s not obvious why that is. My take is that Dollarama is really good at doing three things:
- Choosing what products to buy.
- Choosing what prices to sell that product at. Dollarama buys high-margin items and undercuts its competition on pricing.
- Cutting out the middlemen. Dollarama sources a lot of its product directly from manufacturers rather than going through distributors.
An overview of retail business models
Sell items at high margins
A department store might sell items at a higher price than discounting competitors like Walmart and Target.
Some retailers list most of their inventory at high margins, with constantly-rotating sales that lower the prices on some portion of its inventory. This has to do with consumer psychology. Many consumers will assume that the quality of a product is related to its normal retail price. They will also think that a product discounted significantly from an inflated retail price is a compelling buy.
Sell items at lower prices and make it up on volume.
Use low-margin products to attract shoppers into the store, where they will hopefully buy high-margin items
For example, many supermarkets will sell milk very close to its wholesale price. A retailer might also run loss leaders where they may sell items at slightly below their wholesale price, e.g. Coca-Cola.
High margin items would be things like:
- Impulse purchases. Many retailers will have these items lined up by the checkout area. Some of them layout the store in a way where the customer has to walk by every single rack on impulse items as part of the checkout line (e.g. Marshall’s, which is owned by TJX).
- Snacks and junk food.
- Cosmetics. Many retailers will put cosmetics at the front of a store where the shopper first enters the store (e.g. pharmacies like Shoppers Drug Mart and department stores).
- Anything you would find at Dollarama. For example, a pregnancy test that retails at $7 elsewhere might retail at $1.25 at Dollarama.
Some electronics chains are heavily dependent on getting the consumer to purchase high-margin extended warranties (e.g. Best Buy). They heavily discount select items to generate foot traffic to the store and try to make it up by selling extended warranties and electronics at non-discounted prices. The sales staff may be heavily incentivized to sell a lot of extended warranties with quotas, bonuses, and pressure from store managers.
Obviously there are convenience stores that make money from impulse purchases like snacks, drinks, prepared foods, cigarettes, etc. Consumers may pay for convenience via higher margins.
Some consumers want to do all of their grocery shopping at a single store. Taken to an extreme, some countries have “hypermart” format stores with massive footprints and very large selections.
Some retailers like Whole Foods offer a wide selection of high-end items that are difficult to find elsewhere. A retailer like Trader Joe’s has a selection of organic and specialty products at lower margins than Whole Foods; Trader Joe’s does not charge as much and focuses more on discounting.
Some American dollar stores sell consumer staples like milk (milk does not have good margins) so that the broader selection attracts more shoppers into the store.
Dollarama’s business model
The way I see it, Dollarama sells an eclectic mix of high-margin products at prices that undercut other retailers. It does not run loss leaders or sell items close to wholesale cost to try to lure shoppers into the store. Its relatively lower prices are what attracts shoppers. For example, it sells the same items that a convenience store does but at aggressive prices.
The (limited) selection at Dollarama also has some overlap with supermarkets, stationary stores, pharmacies, etc. etc. Dollarama sells their high-margin items at much lower prices. A $3-4 bag of chips would sell for $2. A $4-5 bag of branded cough drops (e.g. Ricola) sells for $2 at Dollarama. In many ways, Dollarama snipes the most compelling items- high-margin items that can be sold at high volumes.
One limitation of this business model is that shopping at Dollarama is not the most convenient due to its eclectic selection. Consumers can buy cereal at Dollarama but not milk, so shopping at Dollarama is essentially a supplemental trip on top of their normal grocery shopping. It takes time for the consumer to understand what Dollarama sells and to figure out what the great deals are (e.g. pregnancy tests). Weirdly enough, the low prices at Dollarama sometimes cause consumers to mistrust the retailer. Some consumers assume that $1.25/$1 pregnancy tests aren’t reliable and that Dollarama food is close to expiration. (In reality, most food items at Dollarama turn over quickly so freshness should not be an issue. Dollarama food items generally have a “best before” date rather than an expiration date. Food can still be eaten after its best before date though it may not taste as good.)
Unlike other dollar stores, Dollarama actually sells many quality products including brand-name foods, cleaning supplies, and toys as well as unbranded products that are good quality. While I believe that Dollarama attracts more higher-income customers than its dollar store peers, I believe that some shoppers do get annoyed when Dollarama only offers a low-quality version of a product.
Dollarama does not take the $1 gimmick too seriously. Over the past several years, it has introduced higher price points and is moving towards some $4 items. I believe that this helps Dollarama selectively choose from a wider universe of products to find the most profitable items to sell. It should also help Dollarama offer higher-quality products. Because Dollarama discounts so heavily anyways, I believe that consumers are willing to pay extra for higher-quality products.
Value creation / efficiency
I suspect that where Dollarama generates the most value is from finding manufacturers that do a poor job at marketing and designing their products.
- Language and cultural barriers. Some companies are quite inept at selling their product to foreign countries with a different language. They may have poor execution on little details like having translations that make sense and do not have spelling mistakes (e.g. qualisy cable). I suspect that it is difficult to hire a good translator when you don’t understand the foreign language. This may explain why so many Chinese products have terrible translations. (The opposite is also true- some American products have terrible translations. Hasbro’s Wizards of the Coast apparently does not hire good translators for its collectible card game products.)
- Product design. Dollarama buys some product that is specifically made for them. The packaging clearly states Dollarama’s retail price for that item (e.g. $1.25, $2, etc). The product may not list the manufacturer’s name because Dollarama doesn’t want its competitors going to the same manufacturer.
- Middlemen. Cutting out distributors improves Dollarama’s profitability.
Dollarama makes buying trips to China (currently three times a year). They source product from other international countries like Germany and Turkey.
On top of that, Dollarama does find unique and unusual products that work well for its unique customer base. For example, it buys repackaged sports cards and CCG (collectible card game) cards from Presstine Marketing. A package of Magic: the Gathering (MtG) cards retailing at C$1.50 has around 10-15 cents worth of cards inside. The gross margin is likely around 80%+ (assuming a wholesale cost of 30 cents as the worst-case scenario after packaging and the manufacturer’s markup). Specialty retailers and card shops sell official MtG product with a wholesale cost of around US$2.14 for a retail price of around US$2.50 to $4. That translates to margins of 14% to 46.5%. This is a whopping difference in margins. Young kids (and parents of young kids) who do not care about the secondary market value of their cards might find value in the repackaged product sold at Dollarama- they’re paying for C$1.50/15 cards with the Presstine/Dollarama product rather than ~C$3.54/15 cards with official MtG product. (*More experienced and older MtG players would look at the repack product and see terrible value.) Here’s a picture of the Presstine product with custom packaging for Dollarama showing the $1.50 price point:
Now let’s compare Dollarama to big box retailers, which do not do as good a job at buying. In fact, they outsource their buying and retailing to companies like Excell Marketing and Beckett Associates / MJ Holdings. (The websites list all of their clients such as Walmart, Target, Gamestop, etc.) Many big chains basically outsource their core business to those two companies, which basically lease space in the store and give the retailer a small cut of the profits. That arrangement is inefficient for various reasons (I will use Target as an example):
- It does not take advantage of Target’s supply chain. As far as I can tell, Excell has to drop-ship inventory to each Target store from its single warehouse whereas Target has a network of distribution centers and warehouses. Then every few weeks, an Excell contractor will go to the store and restock shelves.
- A lack of boots on the ground. Because the contractor is at the store every 1-4 weeks (depending on the volumes being sold through the store), there is a delay as to when the card section is tidied up and restocked.
- Arbitrage. Occasionally, there will be supply/demand imbalances for a particular product that will cause the market price (e.g. eBay, Amazon) to exceed the MSRP. Because contractors come in infrequently, they are not nimble enough to quickly raise prices. Specialty retailers were savvy enough to raise the prices on “Battle for Zendikar fat packs” to around $55 while consumers were buying them from chain stores at $40 and selling them on eBay. Companies like Gamestop and Toys R Us tend to be savvier in raising prices (on products other than collectible card games; both use Excell or Beckett), while companies like Target try to sell items at MSRP and to limit how many units that can be purchased by resellers.
- Alignment of incentives. Excell eats the cost of any shrink that occurs, so Target employees have less incentive to protect Excell’s inventory. Sports and CCG cards tend to have high shrinkage because they are easy to steal and because of customer demographics. Also, because individual cards vary in value, customers will damage the product to find all of the valuable cards. Or, they may search the packs to find all of the valuable cards and leave the worthless packs behind. Avid sports card enthusiasts try to avoid buying packs from big box retailers due to fears about pack searching (unless they are the ones searching the packs).
- Some lazy contractors will not restock the shelves like they are supposed to. After a few days of unopened boxes sitting around, Target employees might bite the bullet and restock the shelves themselves. In general, this is an issue with scan-based trading and vendors who hire poorly.
- Retailers don’t protect the product appropriately. Specialty stores will keep these high-shrinkage items by the cash register or behind a case. (Target is actually very sophisticated in protecting shrink as it has undercover shoppers, cameras everywhere, big data on the IT side, locked cases and spiderwrap to protect high-value items, staff trained in aggressive hospitality, etc. etc.)
- The packaging is not retail-friendly. Some customers may try to get refunds on resealed packs full of worthless cards. To a poorly-paid retail employee that does not specialize in collectible cards, it may not be obvious to the employee that certain refund requests should be denied. Furthermore, the manufacturers do not discourage the practice of pack searching by making packs weigh the same (some people literally bring a digital scale into a store and weigh the packs to find heavier foiled cards that are more valuable).
- Release dates. For MtG, the manufacturer (Hasbro’s Wizards of the Coast) spends marketing dollars on building hype for each product release day. It does not allow retailers to sell product before that day (except for pre-release events). Retailers like Target could respect the release date by coding it into their IT systems. During checkout, the sale can be rejected if the item would be sold before its release date (this exists for new DVD releases). However, this IT integration was never implemented. In practice, retailers do accidentally sell product before the release date. So, the “solution” is to delay shipments to stores so that store shelves do not have MtG product until a few days after the release date.
Had these big box retailers gone directly to the manufacturers and purchased the same products, I think that they would be able to work out a more efficient system without middlemen taking a cut.
Dollarama crams as much product as possible onto its store shelves. Dollarama is not unique in this regard as computer part retailers and toy retailers like Toys R Us also cram their store shelves with inventory.
I suppose that the downside to this is that the store doesn’t look as good, so consumers might think that the products sold in the store are lower quality. That being said, square footage is a valuable resource that should be optimized.
Dollarama doesn’t use them. This may make it a little more difficult for customers to find items in the store due to inconsistencies in store layout. However, it does provide Dollarama with flexibility in choosing what retail spaces to lease.
One of the issues that Target faces with its planograms is that sometimes its endcaps are empty. (Endcaps are the displays at the end of an aisle. Products displayed in endcaps sell better.) It dedicates some of its endcaps for clearance merchandise. If there is not enough clearance merchandise, then its premium endcap space may be a little barren.
Dollarama products do not have a lot of complexity in terms of their merchandising and sale. Dollarama does not sell produce, so it does not have to worry about spoilage. Employees do not have to inspect produce shipments for quality issues or missing quantities.
Because almost all of its products are cheap and have virtually no secondary market value, there is not much of an incentive for employees to steal inventory. There is less effort needed to ensure that the counts in the shipments are correct and less effort needed to monitor employees for theft (though stealing from the cash register would be an issue, such as cashiers not charging their friends during checkout). Part-time and full-time shoplifters avoid Dollarama because the stores have nothing worth stealing (whereas any retailer selling electronics has to worry about professional thieves who steal thousands of dollars worth of goods). That being said, Dollarama still has shrink issues since some customers will steal instead of paying for their purchases. Their anti-shrink techniques aren’t as sophisticated as other retailers since they don’t train their staff to ask customers if they need help (the human contact makes shoplifters feel less anonymous, which is why Wal-Mart employs greeters).
For specialty items like Magic: the Gathering cards, Dollarama sells a version of that product that does not require them to respect release dates, pack searching, refund scams (e.g. customers returning resealed product), or to worry that much about shrink.
Refunds and exchanges: officially, Dollarama does not allow refunds or exchanges. The obvious downside is that Dollarama does not provide great customer service.
A technology backwater
Dollarama did not use as much technology as it could have. It has historically been very conservative and has pilot-tested new technologies before rolling them out. It abandoned some technologies like credit card payments (which likely had to do with credit card processing fees versus additional sales gained).
It took until 2011 for Dollarama to roll out point-of-sale systems across all of its stores. I suppose the challenge there was ensuring that ALL of Dollarama’s inventory had barcodes, which makes sourcing good deals more difficult. One of the advantages of POS is that the data generated can be very helpful in detecting employee theft. POS also helps to keep track of inventory and help to reduce the frequency of manual inventory counts (though such counts are still needed due to shrink).
At the other end of the spectrum, a retailer like Wal-Mart wasted a huge amount of money on technologies (e.g. RFID) that don’t work well in practice. Target’s Canadian operations lost a shocking amount of money since it could not get its technology to work, causing its supply chain to break down and its store shelves to go unstocked.
Wrapping it up
From what I can tell, Dollarama’s success can largely be attributed to its buying strategy. It was very entrepreneurial in scouring the globe for deals and in cutting out middlemen. Contrast this with chain retailers that use the services of Beckett Associates and Excell Marketing:
- Beckett Associates / MJ Holding (website)
- Toys R Us
- Walmart Canada
- Excell Marketing (website, archive.org)
- Rite Aid
- Giant Eagle
- Five Below
- Loblaws (not a current client)
- Casey’s General Store
- Mills Fleet Farm
- Walmart (Beckett now handles Walmart)
It seems to me that the buyers at these large chains haven’t figured out that they don’t need to outsource retailing to these middlemen.
At the end of the day, it just so happens that Dollarama can generate a lot of value by buying smart and undercutting everybody else on high-margin items. So while Dollarama stores are cluttered, are not that pretty, and are technologically backwards… they are insanely profitable. It’s an interesting business model.
*Disclosure: I do not own any Dollarama or Target stock.
Dollarama: It’s a wonderful business but… – An old post that looks at Dollarama’s ever-increasing related party transactions.
Dollar stores and Dollar Tree – My 2013 post on dollar stores.
How Dollarama turns pocket change into billions – An insightful article on Dollarama
But it was just getting too hard for Rossy and other buyers to hit the sweet spot: items that could be sourced at around 28 cents, and thus sold profitably for $1. There were also limits to how much more the chain could resort to sizing tricks—like offering nine erasers instead of 12 for $1, or further reducing the sizes of items like Pine-Sol below those sold in other stores (see chart, above). “You know, we’re there negotiating not for Christian Dior type of stuff,” Rossy says. “We’re fighting for 30-cent items and 28-cent items. And now we can go to 40 cents,” he says.
Appendix: prices of MtG cards
The Presstine product consists of 1 rare and 14 non-rare cards. Rare cards can be purchased on the secondary market in bulk for around 10 cents / card, though I do not know if Presstine is able to obtain lower pricing. Non-rare cards can be purchased for around half a cent per card. Simply Google “mtg bulk rare” to find pricing. I do not know what markup Presstine Marketing applies to its repack products; one webpage suggests that the wholesale cost is 65 cents / pack though I would assume that the buyers at Dollarama negotiated a much lower price.
One specialty store / card shop (Derium’s) has a Youtube channel where the owner gives insights on his store’s economics. A booster box with a manufacturer-suggested retail price of US$144 costs him around $77+. He will sell that booster box in-store for $90, for a measly 14% margin. Stores may also sell packs of 4 boosters for $10 (MSRP $16), for the same 14% margin. Due to the game’s popularity, this business model is ok since these products sell extremely quickly shortly after the release date. Specialty retailers receive subsidies (sort of) from Wizards of the Coast for promoting organized play and for selling large amounts of product. They can “build allocation” and receive higher allotments of hot product that can be sold at higher margins. A box of “Eternal Masters” with a wholesale price of around $130/$160 (MSRP $240) will sell for upwards of $230+ (36% margin for a $160 box sold at $250). In general, the economics of owning a card shop is not very good because too many people own and operate them for very little pay.
Margins alone don’t tell the whole story because these products turn over extremely quickly shortly after the release date (once the excitement dies down, inventory turns are slower). As a result, MtG products tie up very little shelf space and not that much capital. However, I suspect that Dollarama has reasonably high inventory turns on repackaged product from Presstine given that there are two SKUs allocated for MtG product instead of only one.