Image: Familiy Dollar store
Bebeto Matthews  /  AP file
A customer shops the grocery section at a Family Dollar discount store in Brooklyn. Dollar stores have fared well in the recession but could face challenges in an economic recovery.
Alison
By Allison Linn Senior writer
msnbc.com
updated 5/13/2010 7:36:24 AM ET 2010-05-13T11:36:24

Jim Bowman had never been inside a dollar store before last summer, when a colleague suggested that he try one to get a deal on reading glasses.

“I walked in there and I (thought), ‘Whoa, look at this, it’s unbelievable,’ ” Bowman recalled.

The 58-year-old now regularly shops at dollar stores for deals on such things as paper towels, rubbing alcohol and soup. But there are some things he won't buy at the bare-bones discount retail outlets.

He checks items like toothpaste carefully to make sure they are exactly the same as what he would buy elsewhere, and he avoids any sort of eye drop and most food items.

"That's one of those things I'm concerned about," he said of the food items.

Bowman embodies the challenge facing discount chains including Dollar General, Family Dollar and Dollar Tree. The small-box retailers generally have seen sales pick up in the recession and their market has expanded beyond their traditional lower-income demographic. But as the economy improves they could face a problem hanging onto some of their newest customers, analysts say.

The companies will have to pay attention to areas where they sometimes have been lacking, including keeping stores clean and aisles clear. And in a rebounding economy they will have to overcome the perception that their goods are lower quality or less trustworthy.

“When you’re not feeling quite as financially strapped, you might get a little fussier about what it’s like to go into the store,” said Meredith Adler, a senior research analyst with Barclays Capital Equity Research.

Still, Adler said the dollar store segment is likely to benefit from the difficult economy for years to come, because many Americans are still struggling and others have adopted thriftier habits.

“I personally don’t think that value is going to stop being of interest overnight,” Adler said.

More food, necessities
Dollar stores have been around for decades, traditionally offering low-income shoppers a relatively small assortment of goods at steep discounts. Even before the recession began, some dollar stores had begun offering more food, toiletries and other necessities, and fewer discretionary items such as clothing or gifts.

That shift accelerated as the economy took a nose dive, prompting a much wider swath of Americans to look for the cheapest prices on necessities and cut spending on discretionary items.

“(We) adapted to the changes in demand patterns as our customers faced some very difficult times,” said Jim Kelly, chief operating officer of Family Dollar, which operates more than 6,700 stores in 44 states.

At Family Dollar, Kelly said that meant adding more consumable products that people use every day, plus offering more store-branded items for people who could no longer afford name brands.

Tim Reid, vice president of investor relations for Dollar Tree — which actually prices all its products at $1 — said the switch to more necessities also helped draw shoppers to the store more often, rather than just when they needed party supplies or other discretionary items.

The hope is that those customers will continue to come in as frequently even after the economy improves, and they may even have a bit more money to splurge on things like toys or candles.

“Whether the economy in general is weak or strong, people understand good value, and I think we are positioned very well to actually do better with an improving economy,” Reid said.

Dollar General, which operates 8,800 stores in 35 states, declined to comment for this story, citing the company’s quiet period before an earnings announcement.

More affluent customers
While many dollar stores say their core customer continues to be a lower-income shopper, they also believe the recession has drawn in more middle-income shoppers.

“(There is) plenty of anecdotal evidence that might suggest a more affluent customer,” said Reid, of Dollar Tree, which operates more than 3,800 stores in 48 states.

Bowman, the man who first visited a dollar store for reading glasses, is among the middle-class shoppers trying out dollar stores as a result of the recession.

Bowman said his personal finances took a serious hit when the stock market plummeted following the financial crisis in late 2008, wiping out a large chunk of his retirement. He also worries that he could be laid off from his job in technical support at the University of Tennessee at Chattanooga, because of state funding cuts.

“I’m constantly watching over my shoulder, and I’m not going to spend a nickel that I don’t have to,” said Bowman, who goes so far as to shop with a legal pad and calculator to make sure he is getting the best deal.

Adler said the growing number of middle-class shoppers trying out dollar stores follows a longer-term trend.

“The acceptance of dollar stores in general has been going up over time,” she said. “It was no longer looked down upon to go to a dollar store.”

Nicole O’Brien had rarely stepped foot in a dollar store until recently, but she decided to give Dollar Tree a chance after hearing good things about it from her mother, mother-in-law and some friends.

The 28-year-old administrative assistant, who lives in the Phoenix suburb of Queen Creek, now regularly shops there for cleaning products, toiletries, canned vegetables, apple sauce, peanut butter and toys. Those are things she used to buy at places like Target and Wal-Mart.

“The stuff that they have is substantially cheaper, and it’s not like you’re sacrificing a lot on the quality,” O’Brien said.

Adler, the analyst, said all of the major dollar stores have made a concerted effort to focus on quality over the past few years, including highlighting name brands and responding swiftly to recalls. She said the dollar stores also have acknowledged that they needed to focus more on customer experience to attract and retain a broader range of shoppers.

“We have to maintain a low-cost environment, but low cost doesn’t mean that you can’t be clean and that you can’t have a pleasant shopping experience,” said Kelly, of Family Dollar.

Kelly, concedes there’s a risk some of new dollar store customers will go back to their old retailers once the economy improves. But he argues that other factors, such as stock market losses, a jobless rate that is much higher than normal and tighter access to credit will affect many people for years.

“You can’t bat a thousand on this,” he said. “On the other hand, it would seem to me that this country is in for an extended period of time where value is going to be an important part of the buying decision.”

Over the next few years, Adler expects that dollar stores will continue to add new stores, especially in urban areas and states the stores haven’t yet penetrated. She said all the chains have plenty of room to make their businesses more efficient. That includes adding more advanced technology and getting better at things like offering different prices and product mixes in different parts of the country.

“This has been a pretty unsophisticated group of companies,” she said.

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