Discount Distortion: How Dollar Stores Actually Charge You More

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Dollar General StoreThanks to the recession and its long, slow recovery, discount stores are in vogue, and the hottest of the markdown merchants are dollar stores like Family Dollar (FDO), Dollar Tree (DLTR), and Dollar General (DG). Their revenues are exploding, earnings are off the chart, and stock prices are on the rise.

That's good news for investors. But what about everyday shoppers? Are they really getting their money's worth when shopping at these discount stores?

You would think the biggest discounts could be found at dollar stores; it's right there in the name. If it's a dollar it must be cheap, and if it's a dollar it must be a discount.

But a discount is more than just the cost of an item -- it's the amount that item is discounted versus the competition.

A true discount retailer will make less money on each item it sells than its competitors. And this is where dollar stores start to look a lot more expensive than competitors.

For example, for every dollar it sells, Dollar Tree makes $0.35 in profit and $0.067 in net income for owners. At Walmart (WMT), just $0.24 of each sale is profit and only $0.035 ends up in the owner's pocket. So who is the best discounter?

Company
Q1 2012 Sales Growth
Gross Margin
Net Margin
Dollar Tree
11.5%
35.0%
6.7%
Dollar General
13.0%
31.5%
5.5%
Walmart
8.6%
24.1%
3.5%
Target
6.1%
30.2%
4.2%
SuperValu
(5.0%)
22.8%
(5.1%)
Nash Finch
(3.7%)
7.6%
0.0%
Source: Company earnings releases.

It turns out that grocery stores are actually the most discounted places to shop (although that is skewed somewhat with food's high turnover).

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And the least discounted? You read the chart right -- it's dollar stores.

Discount Stuff or Just Cheap Stuff?

Dollar stores tend to carry a lot of off-brand items that cost less to begin with. So in order to do a true apples-to-apples comparison, let's look at the cost of some well-known name-brand products that can be found both at dollar and big-box stores.

I looked up the price for Tide laundry detergent, Planters mixed nuts, and Huggies diapers at both Dollar General and Wal-Mart. These were the first three products I looked up (which you'll have to take my word for) so I'm not picking and choosing winners here, just looking to do an apples-to-apples comparison. What you can see below is that on a per-unit basis, Walmart is significantly cheaper than Dollar General with every one of these products.

Company
Tide Laundry Detergent
Planters Mixed Nuts
Huggies Snug & Dry Diapers, Size 4
Dollar General
$10.95 -- 75 fl. oz
$0.15 per oz
$4.30 -- 8 oz
$0.54 per oz
$19.50 -- 74 count
$0.26 per diaper
Walmart
$11.97 -- 100 fl oz
$0.12 per oz
$6.48 -- 15 oz
$0.43 per oz
$22.94 -- 98 count
$0.23 per diaper
Walmart discount vs. Dollar General
18%
19.6%
11.2%
Source: Company websites

Here's where it gets interesting: Walmart may be cheaper on a per-unit basis, but what is also true in every case is that the price tag on each of these items at Dollar General is less than the price tag of the item at Walmart.

Size matters. Sizing products differently is a trick retailers use to obscure the true cost of their products. And from this small sample it appears that your dollar doesn't go as far at Dollar General, and the retailer makes more money on each dollar you spend.

So be a smarter shopper. Just because a store has "dollar" in its name doesn't mean it's less expensive than the competition. In fact, it's likely that you're paying more at a dollar store than you would at Walmart or Target for the same item. Keep that in mind next time you are looking for a discount. It may just save you some money.

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7 Ways Stores Get You to Make an Impulse Purchase
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Discount Distortion: How Dollar Stores Actually Charge You More

Stores pull together color-coordinated items in matching or complementary hues as part of a thematic display designed to spark impulse purchases and multiple sales.

A retailer will spotlight a spring-themed bathroom display, for example, grouping blue, yellow and green shower curtains, bath towels, a rug and bath mat "so that it makes a really nice statement," Steve Ryman, the former vice president of home for both Sears and Kmart (SHLD), who now runs retail consultancy Ryman Consulting, tells DailyFinance.

The display is so nice that a shopper who's in the department simply to buy some new shower hooks suddenly thinks, "'It's time to refresh my bathroom -- and I can do it for $25!' -- and they throw it all in their cart," he says.

Everything from pineapples and palm trees to owls and peace signs have at one time or another captured the imagination of the American consumer -- prompting them to shell out cash for all manner of merchandise sporting the motif du jour.

Often a trendy motif starts at the high end, "then filters its way down to every store in the nation," Ryman says.

When a look is at the height of its popularity, retailers know shoppers are under its odd spell -- but only for a limited time. So while the going's good, they conjure up store displays that enshrine the motif, often featuring "totally unrelated products," Ryman says.

Accordingly, a shopper might find they've brought home a pineapple-themed wreath, bath accessory, doormat and candle.

Retailers use "punitive pricing promotions" to spark impulse sales, says Mark Cohen, professor of marketing in the retailing studies department of Columbia University's business school, and a longtime retail veteran who was the former CEO of Bradlees and Sears Canada and has held positions at the Gap (GPS) and Lord & Taylor. Such promotions include buy one and save 20%, buy two and save 30%, buy three and save 50% type sales.

Stores trick shoppers into thinking, "'the more you buy, the more you save' -- without regard to how much you actually need," Cohen says. "Consumers love these deals, which in fact reward their impulsive behavior."

Call it retail theater: Stores hire well trained and bubbly marketing experts to draw you to their product demonstrations by staging tempting, multi-sensory experiences.

The seduction begins with the overall look and feel of the demo area, with a display that "catches your eye," Ryman says.

Then stores further hook shoppers with food and drink. So a browser sampling, say, a new cheese cutter, is also fed "cheese and sausage, and at the same time they're selling you the cheese cutter, they're selling you knives, six new wine glasses and a bottle of wine," Ryman says. "Retailers maximize the sale by putting together as much related product as they can."

So the now semi-tipsy shopper who didn't even think he needed a cheese cutter has not only purchased that implement, but all the other accouterments, too.

Out with the old, in with the new: Stores send this message to shoppers by playing up new merchandise -- even when its newness is dubious -- by showcasing the goods in a fresh setting, prompting shoppers to make an unplanned purchase.

Retailers highlight presentations of current-season clothing, for example, "which by virtue of fashion, silhouette, or features and benefits, makes last season's merchandise appear to be dated or obsolete," Cohen says. "It plays to a customer who doesn't want to be considered behind the times, without regard to whether or not this new merchandise is actually better or truly different. This is why new season merchandise is invariably different in the way it's colored/packaged and presented so as to make last year's version less attractive." Retailers know that "new and engaging, if only by way of packaging, promotes impulsive buying," Cohen says.

And with consumer packaged goods like cereal, stores can accomplish the same thing "merely through the use of the word 'new' on a package, insinuating the importance of what is typically an insignificant reformulation."

Stores will also try to coax an unplanned purchase from a shopper's planned purchase, a common ploy at electronics chains. Brent Shelton, a spokesman for money saving shopping site FatWallet.com, tells DailyFinance, "Electronic accessories such as cables, as well as extended warranties, are two common up-sells."

"At many electronics stores, if you're purchasing a big-ticket audio-visual item like an HDTV, computer or home theater system, one retail tactic is to try to get you to buy over-priced audio-visual cables -- HDMI, USB adapters, connectors, Monstercables, etc. -- [as well as] speakers, remotes," he says.

These stores also push shoppers to buy extended warranties, which consumer advocates say are mostly a waste of money for a variety of reasons. For one, products rarely break within the extended warranty period, but instead after they've long expired.

What's more, "many credit cards will extend the warranty just for using their card," Shelton says. "And you should find out before swiping a big ticket item at the register."

These displays, featured in prominent areas on a store's selling floor, scream: Buy this merchandise!

Strike zones are "in-your-face, impossible-to-miss displays of merchandise that [the retailer] wants you to notice whether you're looking for something or not," Cohen says. The implicit message is, "It's new, it's special and you've got to check it out, and hopefully, [buy] it."

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Motley Fool contributor Travis Hoium does not have a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool. The Motley Fool owns shares of SUPERVALU. Motley Fool newsletter services have recommended creating a diagonal call position in Walmart Stores and buying calls on SUPERVALU.


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