Dollar stores and the recession: You know the economy is in bad shape when customers say dollar stores are…

Commentary about business and finance.
Aug. 3 2011 5:15 PM

When Dollar Stores Are Too Expensive

You know the economy is in bad shape when customers can't afford to shop at dollar stores anymore.

99 cent store. Click to expand image.
Even dollar stores are struggling

When he was Fed chairman and had access to the best economic data and minds on the globe, Alan Greenspan famously liked to forecast the direction of the economy by studying sales of men's underwear. Even during the best of times, underwear purchases remain pretty flat, he noted. (What dude who has just gotten a raise thinks: "Ah yes! I'll upgrade my entire collection of briefs now!") Only during the worst of times—when people are really, really cutting back—do boxer and brief purchases drop off.

The reverse logic usually holds for America's dollar stores. Customers flock to the chains, which sell thousands of products for a buck or $2 or $10, when times get tough. When the economy improves, they shop at nicer outlets, like Target. But there are some worrisome signs that the prolonged economic malaise has changed even this retail paradigm. Middle-class households remain reluctant to spend. And cash-strapped consumers are finding even dollar stores a bit too expensive.

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To be fair, Dollar Tree, Dollar General, and Family Dollar, the three big national chains, all posted strong profits in the first quarter of the year, the last for which data is available. That is not just because they are opening new stores but also because same-store sales have continued to grow as more and more customers trade down.

Nevertheless, all three reported ominous data in the past few weeks. The Wall Street Journal noted that two of the three missed earnings targets. And the companies' investor notes report that customers are buying fewer discretionary items, like hand lotion and decorative goods, and more "consumables" and household items, like toilet paper.

In short, families are shopping more at dollar stores. But they are buying only what they need. They are picking up low-margin goods, cheaper per unit at dollar stores than places like Wal-Mart, and sold in smaller packages to let customers spread purchases out.

The story gets worse the more you dig into the reports. Dollar Tree, for instance, said that it saw its gross profits thinning, "a result of the impact of stronger sales of lower-margin consumables, increased promotional markdowns, and higher freight expense." In an earnings call, as reported by the Journal, Dollar * CEO Rick Dreiling explained that the stores let margins drop because they did not feel comfortable passing price increases onto consumers. "We have 228 items that are priced at $1 that we think are incredibly important to our customers that we elected not to take price increases on," he said. "This sounds almost silly, but a $1 item going to $1.15 in our channel is a major change for our customer."

Chalk it up as one more sign of weakness in consumer spending. Wal-Mart visits are down 3 percent, with some customers complaining that prices are too high there. A May study from Deloitte reported that 73 percent of shoppers are making fewer trips to the grocery store, 75 percent are buying lower-priced items, and 48 percent are buying fewer grocery items. This week, the Department of Commerce announced that, even though personal income ticked up in June, overall consumer spending declined.

The backdrop is the persistent, perhaps worsening, economic malaise, combined with rising food and gas prices. Today's ADP report on hiring suggested that private employers added more than 110,000 jobs in July. (We get the government's number on Friday.) But layoffs are also increasing. Borders will lay off its 10,700 remaining employees when it liquidates. Pharmaceutical giant Merck is shedding 13,000 jobs. A spate of financial companies, including Barclays, Credit Suisse, and Goldman Sachs, has announced staff reductions too. According to the outplacement firm Challenger, Gray, and Christmas, last month saw a "sudden and unexpected burst" in downsizing.

Some economic prognosticators now see a double-dip on the horizon—a possibility considered so slim as to be unmentionable just a few months ago. "The indicators suggest that the economy has at least a 1-in-3 chance of falling back into recession if nothing new is done to raise demand and spur growth," Larry Summers, the former Harvard president, Treasury secretary, and Obama economic adviser wrote this week. PIMCO's Bill Gross thinks the odds are worse. We are at the "tipping point" of recession, he told Bloomberg.

Of course, it could just be a transient soft spot. Jobs and spending could track back up in the third and fourth quarters of the year. But right now, little data supports that optimistic view. As for underwear sales? Well, the market research company NPD says they were up 14 percent for the three months ending in February. No word on how they have fared since then.

Correction, Aug. 11, 2011: This article originally misidentified Dollar General CEO Rick Dreiling as the head of Dollar Tree. (Return to the corrected sentence.)

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