Fuel and convenience retailing are at a crossroads.
Concerns have been raised for years about the long-term outlook of motor fuels demand, and the COVID-19 pandemic is providing a glimpse of what that future might look like. It isn’t pretty. Many retailers’ business models were not prepared for this scenario, and it was only through the sheer luck of crude oil’s crash that many are weathering the storm.
Much of the industry continues to operate what might be referred to as a “traditional” convenience store. Beyond impulse and necessity, there are few reasons for consumers to visit these stores, since they are not destinations. Their value proposition is convenient access to “gas, smokes and Cokes” as people move from Point A to Point B along predictable routines.
This model worked well for years. Unfortunately, a less-favorable future was lurking just over the horizon even before the pandemic. From rising fuel economy and shifts toward remote work to electric vehicles and the e-commerce-fueled right-sizing of America’s over-retailed landscape, there was likely to be a shift in demand away from the traditional convenience store.
The pandemic has been a test run. It’s sufficient to say we accelerated in time by a decade in a matter of days, and the question retailers should ask is not, “Who was able to weather the storm?” but, “Who was prepared to thrive amid demand destruction?”
Even now, as the reactionary period cools, many trends remain advanced beyond where they would have been had the pandemic never occurred. It’s possible that we may never truly “return to normal.”
This comes at a time when the industry had already diverged into three distinct business models — each with clear paths toward success in this new normal. For everyone else, now is a good time to pivot and think beyond traditional notions of “convenience.”
Bank Error: Collect $200
Retailers cannot take credit for the lifeline provided by crude oil’s crash.
Rather than reflecting sustainable business models in times of low demand, the resulting margins were a fluke that enabled retailers to weather a black swan event — essentially a real-life version of Monopoly’s Community Chest bank error.
Periods of steeply falling gas prices create positive feedback loops for retailers as their replacement costs fall faster than retail prices. Unfortunately, this is a double-edged sword. When costs rise or stagnate, the retail price tends to normalize more quickly. Gross margins get squeezed as the competition heats up to maintain market share.
A good example of this is the post-2015 crash recovery. Commodity prices experienced doldrums until late 2018. The lack of significant price volatility forced fuel-forward retailers to cut into unit margins in an attempt to differentiate their brands and maintain market share.
The challenge moving forward is that there will be significant pressure on demand. From increased fleet fuel economy to high rates of remote work, it’s unlikely that we will truly “return to normal.” Growing volume will require stealing market share.
As demand organically declines in the future, prices will fall over years — not days — providing little structural change to this dynamic that we have seen over the past decade. Volatility may also be muted as global upstream investment slows and dampens the possibility of future supply shocks.
To add additional pressure to fuel-forward retailers, data shows that consumers are not loyal to fuel brands and increasingly choose where to refuel for reasons other than price. Altogether, it’s likely that unit margins will settle at historical averages or lower in the coming decade — thereby removing the cushion that was enjoyed in recent months.
Some retailers are positioned to succeed in this environment. The cost structure has changed for a particular segment of the industry, and they can thrive on prices that may be unsustainable for their competitors. Two other segments of retailers are likely positioned with negative fuel break-evens due to a value proposition that begins with their in-store offer.
Let’s take a closer look.
Forks in the Road
The idea of getting lunch or dinner at a gas station was once unthinkable. The stigma surrounding gas station food still continues to this day in a lesser form, but times are changing.
“Just had the best meal I’ve ever had at a gas station here,” said Arnold Schwarzenegger in a 2017 Snapchat story. “It was the best of the best.”
The Terminator had just eaten at Rudy’s Country Store & Bar-B-Q. Although companies like Rudy’s used to be rare, America’s landscape is now sprinkled with them. These retailers flip the script by generating traffic through their in-store offer rather than motor fuels. In many communities, it goes without saying that the best meal often comes from a convenience store.
This shift has led many to conclude that convenience stores in general are shifting toward foodservice. To be fair, the data does suggest as much. In the 10 years spanning 2009 to 2018, foodservice grew from 16.02% of in-store sales to 22.60% — the largest shift of any category. In 2019, foodservice grew even further to 25.10%.
But this is also misleading. It’s a shift largely driven by a particular segment of the industry: quick-service restaurants (QSRs). These food-forward retailers place a high premium on customer experience while deploying robust menus that rival any national quick-service chain.
The Consolidators are taking a different approach. Rather than speaking the language of touchscreen ordering and world-class hoagies, they seek to operate the “traditional” c-store model in the most cost-effective, efficient manner. They do this by creating economies of scale through mergers and acquisitions.
GPM Investments is a prime example. The company began with 320 stores in 2011 and has since grown to nearly 1,400 locations. GPM is now set to grow even further as its parent company enters a proposed business combination with Haymaker Acquisition Corp.
A related investor presentation identifies a long runway for continued consolidation since the 10 largest operators control less than 20% of U.S. convenience retail locations, while 72% of the market consists of chains with fewer than 50 locations.
Taken together, the consolidators and QSRs represent a challenge to the rest of the industry. Nearly two-thirds (62.1%) of the industry are single-store operators. Many are operating fuel-forward, undifferentiated, traditional convenience store formats. They lack the ability to compete with consolidators on price — both in-store and at the forecourt — and they rarely have the ability to draw foot traffic like the QSRs.
There are also larger brands that fail to recognize this divergence. They de-prioritize the customer experience, allow their facilities to age and degrade and scrape the bottom of Maslow’s Hierarchy of Needs with a belief that the “-ines”— cheap gasoline, caffeine, and nicotine — are the path forward. They lack a strong value proposition while the advantages of their cost structure erode in comparison to their more sophisticated competitors.
Amidst these two divergent models is a third: the Merchant-Supported.
While c-stores sell approximately 80% of the retail fuel in the U.S., merchant-supported canopies account for 16% and sell considerably more gallons on a per-location basis — as much as two to three times the national average, according to some estimates. These operations are merely tactical tools in a larger arsenal at the disposal of Costco, Sam’s Club, Fleet Farm and grocers like H-E-B.
Few retailers are in a position to compete with merchant-supported operations on price. Whether
used as a loss-leader to drive visits — or a method to provide discounts within existing shopper networks — this category of retailers is a competitive threat to any fuel-forward brand.
Differentiation as a Survival Strategy
Amid this divergence is a fourth category of retailers: the Bespokes.
These single stores and small chains have created unique destinations that others cannot replicate. From Lou Perrine’s Gas & Grocery and Papu’s Cafe to Fuel City and Stop N Go East Bend, these retailers delight their customers and create memorable, emotional connections. Where else but Stop N Go East Bend will you find nearly 40 beers on tap and an owner who knows most customers by name?
Even if a competitor decided to price lower on fuel, the bespokes have an advantage. The service they provide to their communities is often worth more to customers than the ability to save a few cents on a gallon of gas down
Therein lies the challenge of the present day: A significant number of convenience retailers have failed to take this path or even realize why it’s necessary. They continue to operate dirty, unremarkable, fuel-forward businesses that are not equipped to go head to head with the QSRs, consolidators or the merchant-supported.
Differentiation is more than a catchphrase; it’s a survival strategy. Continued articles in this three-part series will explore these issues in more detail.