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Dollar stores hope wider aisles, better food will get middle America to like them

Dollar Tree said this week it is buying Family Dollar Stores for $8.5 billion or $74.50 a share. The combined company will have more than 13,000 stores and more than $18 billion in sales making it North America's biggest discount retailer. Meanwhile, real estate website operator Zillow is buying competitor Trulia in a $3.5 billion all-stock deal or about $70.53 a share. The transaction will make the combined entity the largest player in online real estate advertising. Finally, speaking of millions of users, Twitter said this week it had 271 million average monthly active users in its second quarter, a 24% increase from last year. Mobile users jumped 29% to 211 million.

With an $8.5 billion merger underway between Dollar Tree (DLTR) and Family Dollar Stores (FDO), fans of the discount retail giants might be wondering what the union will mean for their wallet.

So far, the outlook is pretty bright for shoppers who like to buy more than just their party supplies and holiday candy at dollar stores.

Dollar Tree, which is already the No. 1 dollar-store chain the U.S., will raise its storefront count to more than 13,000 with the addition of Family Dollar. But the chain still faces competition from contenders like Big Lots (BIG) and Dollar General (DG), not to mention retail heavyweight Walmart (WMT), which hasn’t taken too kindly to the fact that dollar stores have been eating into its customer base.

From a consumer standpoint, competition is always a good thing. Dollar stores enjoyed huge gains throughout the Great Recession, but their hold on America’s penny-pinching households has begun to slip. As unemployment rates continue to fall and Americans get their financial mojo back, research firm IbisWorld says dollar stores could see a 4% drop in revenue in 2014, after four years of 0.9% average annual revenue growth.

Analysts predict that to avoid that kind of decline — and keep their remaining penny-pinching customers coming back — discount retailers will scramble to update their technology, improve their product offerings and expand their stores over the next few years.

“Now that we’re getting out of the recession, the challenge for dollar stores is to hold on to this target market that they’ve acquired,” says Zeeshan Haider, an IbisWorld analyst who recently  wrote a recent report on the industry.

Here’s what consumers can expect from dollar stores this year.

More name-brand, high-quality products on shelves

To woo deeper-pocketed shoppers, expect to see dollar stores stocking bigger name household brands, like Heinz and Kraft, Haider says. Family Dollar introduced 400 new food products at 8,000 of its stores in April, while Dollar General has been rolling out supermarket-like Dollar General Markets, which feature fresh meat and produce sections, across the U.S.

Stores may get a facelift, too. “Aisle sizes are likely to [expand] because they want to give that luxurious appeal to their customers,” Haider says. “They want to remove this idea that people have about dollar stores, that you only go there for snacks.”  

Try as they might to dust off their low-end image, dollar-store chains know they’re facing an uphill battle if they want to attract highly coveted middle-class shoppers. So far, the average household income of dollar-store shoppers is less than $30,000, according to a report by Haider. In a 2013 survey by Chicago-based research firm Mintel, one-third of people who earned more than $150,000 said they didn’t shop at dollar stores at all.

Price cuts on toys and games

In dollar stores’ heyday during the recession, a common strategy to boost sales was to lure customers in with super low prices on things like packaged food and household products and hike up prices on items like toys, crafts, games and electronics, hoping shoppers would stick around long enough to buy them.

Haider says dollar chains will have to shift strategy and will likely have to take a bigger hit on margins on more of their product lineup — particularly in the face of competition from an expanding Walmart and it’s ultra-low prices.  

Stores will run more smoothly on the back end

Some of the changes coming to dollar stores won’t be as noticeable to everyday shoppers. Haider predicts stores will really ramp up their point-of-sale and back-end technology to make customer transactions and inventory tracking more efficient.

“They’re going to have to invest more in customer service and train their managers to get familiar with new procedures,” he says. “A lot of that is going to happen behind the scenes.”

Some major dollar-store chains have already made strides in this area. Dollar General introduced a new workforce management system, added WiFi to its stores, and launched an ecommerce site in 2011. Last year, Family Dollar introduced a high-tech security and inventory system to help prevent store theft and keep better track of items that need replenishing.

Expect more mergers and store closings  

With analysts predicting a sharp decline in dollar-store revenue over the next few years, retailers will be looking for ways to trim overhead costs, especially from labor. Haider predicts these stores will cut their workforce by 4.7% in 2014.

“The industry has to consolidate. It can’t sustain the growth that it’s seen over the past five years,” he says. “Single-store operators are very likely going to close down or be taken over by larger players. Walmart may even buy one of the larger dollar-store chains.”

And as dollar stores consolidate, more stores will close. If the Dollar Tree/Family Dollar deal goes through, for example, they will probably close stores in close proximity to one another.

“The advantage these stores have is their ‘right around the corner’ image,“ Haider says. “You’ll still have access to stores, but you might have access to fewer brand dollar stores” as they consolidate.

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