Michael Rollinghoff, President and CEO of The Bargain! Shop Holdings Inc. pictured in fashion department
CHEAP THRILLS
by Joanna Pachner
Photograph by Chris Thomaidis
Article originally appeared in Globe and Mail's October 2007 issue of Report on Business magazine
Michael Rollinghoff, President and CEO of The Bargain! Shop Holdings Inc.
pictured in fashion department
The place isn’t much to look at—red-and-white signs screaming out deals, racks full of last year’s styles, the toy section already a mess an hour after opening—but the prices are adorable. “Look, Mary, a cute little DVD player!” exclaims one shopper upon spying an Audiovox unit for $19.97, quite possibly the best deal available in Canada for a DVD player on this late-April day. It’s a store-opening special at the new Bargain Shop in Belleville’s Bay View Mall. The place has seen better days. Back in the 1960s, it was the shopping mecca of this mid-sized Ontario town, but the action has moved west with the big-box chains, and north to the Wal-Mart and the sprawling Quinte Mall that straddle Highway 401.
For the retirees and middle-class families in this downtown neighbourhood, those shopping opportunities are a car- trip away. Which helps explain why, by 9 a.m., 160 people have queued up at the doors of the new Bargain Shop, forming a line that snakes past the clearance bookstore and the Buck or Two outlet. Promotional flyers had promised coffee, prizes and free lottery tickets to the first 100 customers, but before shoppers can jump into the bargain hunt, they have to file past a very tall man in a grey suit.
Michael Roellinghoff, CEO of the Bargain Shop Holdings Inc., stands at the entrance, like a vicar greeting parishioners. Even though he bends down to say hello, at 6 feet 6 inches, his height forces every customer to crook her neck way back. He has none of the forced glee of many other marketing types: He’s quiet, respectful and slightly awkward.
“Our stores will never win awards for visual displays,” concedes Roellinghoff, who has driven 2 1 / 2 hours from sub urban Toronto to cut the ribbon at the company’s 20th store-opening in the past six months. Still, Isabel Stevens, a single mom who lives nearby, finds the store’s layout and merchandise selection a big improvement over the Liquidation World that was here before. Holding out a boy’s shirt, she says triumphantly, “This is cheaper than Wal-Mart!”
Sandwiched between the giant discounters and the dollar stores, Bargain Shop and other so-called junior discounters didn’t have much hope when Wal-Mart started steamrollering across Canada in the mid-1990s. The U.S. giant’s stadium-sized outlets dwarfed the selection and buying power of the Canadian players, and its ruthless efficiency left rivals no room for operating slack. Through the ’90s, many storied names sank from sight: Bargain Harold’s, Consumers Distributing, Wise, Robinson’s and Peoples, Kresge, Kmart Canada, BiWay. Those that survived recognized they couldn’t compete with Wal-Mart head-on, yet knew, too, that the retail business had been forever changed by the company’s arrival, and they had to adapt—pronto. Fast-forward to 2007: There are more than half a dozen contenders, from Hudson’s Bay Co.’s Fields Stores in the West to the Rossy and Hart chains in the East, and several other players that have near- national scope. What’s more, most are aggressively expanding—and none more so than Bargain Shop.
Today’s opening brings the store count of the Mississauga-based chain to 173, stretching from Port Alberni, B.C., to Antigonish, N.S., and pulls it neck-and-neck with the sector’s sales leader, Giant Tiger Stores Ltd. Bargain Shop, which emerged in 1999 out of what was left of Woolworth, the original five-and-dime chain, hopes to break 300 by 2010. The company’s expansion moved into higher gear late last year, when Genuity Capital Markets, the Bay Street brokerage and private equity firm, paid an estimated $120 million for an undisclosed majority stake. That deal came on the heels of Bain Capital Partners’ blockbuster purchase of Montreal’s Dollarama for over $1 billion, and was followed in March by Kohlberg Kravis Roberts & Co.’s buyout of Dollar General—a U.S. chain positioned similarly to Bargain Shop—for almost $7 billion (U.S.). With annual sales of about $250 million, Bargain Shop attracted more than half a dozen offers, all from U.S. and Canadian private equity firms, and a Genuity principal told reporters at the time that his firm was interested in making more buys in the sector. All of which has left even industry insiders wondering how dowdy discount retail suddenly became so sexy. More importantly, in the scramble to score the best locations in underserviced neighbourhoods, will some contenders get pushed off the field?
Michael Roellinghoff is a charmingly self-deprecating man, a guy who strains to give rivals their due and quickly corrects his wording when he thinks he might have given himself too much credit. Ironically, that understated manner makes him a strikingly believable pitchman, and at a vendor open house in May—held in part to show off Bargain Shop’s new headquarters near Pearson International Airport—he laid out a compelling market opportunity. As slide after slide showed, over the past decade North American retail has been taken over by tightwads. This is especially true among Canadians, who have 20% less disposable income than Americans. Consumers, particularly baby boomers, will splurge on luxury brands one minute, then fight to squeeze every last cent of value from their money the next. As one industry observer puts it, “We live in a pizza and Dom Perignon world.” In fact, the fastest-growing segment of extreme-value shoppers is the affluent.
This shift to thrift has been disastrous for conventional department stores, with their mid-range, mid-price merchandise, but it’s been a boon for discount retail, which has changed in order to better cater to this value-conscious customer. Bargain Shop and its rivals have no illusions that they can replace Wal-Mart in consumers’ lives—the grey-box invader sells more than 50% of general merchandise in Canada, and most value-driven consumers will continue to drive there for periodic big-shops. But in between, Bargain Shop’s typical customer—a middle-class boomer mom with teenaged kids—wants a convenient, neighbourhood store where she can pick up sneakers and Scotch tape and be confident she’s getting a bargain.
To lure her into their outlets, the discount sector has upgraded its product mix and brought in mainstream brands (“There’s no tolerance in the marketplace for junk,” says Roellinghoff). Even more significantly, retailers such as Bargain Shop are doing something that seemed inconceivable when Wal-Mart first arrived: They’re coming back to the cities they abandoned years ago in an effort to escape their big-box competitor.
Like many of its rivals, Bargain Shop retreated during the 1990s to small towns that seemed unlikely to support a retail behemoth; the chain’s “sweet spot” became a 10,000-square-foot store in a 10,000-resident town that was at least 20 minutes away from the nearest big-box discount retailer. But with Wal-Mart now moving into smaller markets—some as tiny as Digby, Nova Scotia (pop. 2,300)—the junior discounters are looking for underserviced pockets elsewhere, and finding them in urban areas like downtown Belleville.
While small towns are great markets—Roellinghoff says Bargain Shop can make a “pleasant” profit in communities as small as 1,000 people—there’s little growth there. Contrast that to urban centres, where rapidly expanding condo and infill developments present a huge opportunity to serve people who often have few retail choices nearby. What’s more, many downtown residents don’t have cars, and with gas hovering at a buck a litre, even those who drive might prefer to skip that trip to the suburban box store. Urban operating costs are higher, but so are the volumes. A neighbourhood of 10,000 homeowners in a former industrial zone can be just as sweet a spot as a same-size small town. Today, roughly one out of every five Bargain Shops is in an urban location, and Roellinghoff wants to open more. Retail analysts confirm the strategy could tap a lucrative market niche. “The small store has the ability to make the staff part of the customer’s life,” says veteran retail analyst Albert Plant. “That’s something Wal-Mart can never do with a 100,000-square-footer.”
It doesn’t hurt that Wal-Mart has been stumbling, facing community resistance, cutting staff and struggling with unsold stock. “Wal-Mart faces the need to properly pay its people,” says Plant. “Slowly but steadily, its cost base is climbing. You don’t see Smiley much any more. Why? Because prices are going up.”
Still, as Roellinghoff himself points out, “we’re not the only ones smart enough to figure this out.” With money cheaply available, many players are expanding. Giant Tiger has scaled up its growth, with a recent focus on the Toronto area. Fields, which until recently wasn’t even on HBC ’s balance sheet, has added 31 stores since American billionaire Jerry Zucker took over the parent company early last year, and it’s planning to open 26 more in 2007—including its first foray into Ontario. SAAN Stores Ltd., which came out of bankruptcy protection in 2005 freed of its worst-performing outlets, is gradually giving its stores a polished new look. The Quebec-based Hart chain opened five Ontario sites in fiscal 2007. Meanwhile, dollar stores are ramping up business, led by rapidly multiplying Dollarama.
In this game of musical chairs, some players are bound to be left without a seat. “There’s a race to fill underserviced neighbourhoods,” says retail consultant Richard Talbot, “and there’s space for only one such [junior discount] store in each of these markets.” Rather than chase individual sites, discount retailers may find it easier—and more lucrative—to get a wealthy investor to fund the acquisition of a rival. Analysts agree that many of the owners of these largely private chains may be asking themselves these days: Should we be predator or prey?
The prospect of ushering in, and profiting from, a consolidation likely lies behind private equity’s sudden crush on discount retail. When, in late 2004, Bain valued Dollarama at 10 times revenue, many industry observers shook their heads at the extravagance. Now the chain is thriving by sticking to a pure
$1 price point and, thanks to a direct import link with China, it’s profiting immensely from the strong Canadian dollar. (Bargain Shop has a fledgling import operation bringing in goods from China to reap the benefits of the rising loonie.) “The extreme-value sector has strong cash flow with low capital expenditures,” explains Matthew Kahn, managing director of GB Merchant Partners, a Boston private equity firm that was a part owner of Bargain Shop until last year. The sector is relatively resistant to economic ups and downs, the cookie-cutter stores are cheap to set up, real estate and labour are plentiful and inexpensive in small towns, and because inventory isn’t based on fickle fashion, there’s little risk. “All you do is rent a space, put up basic fixtures and you’re off to the races,” says Kahn. Adds Roellinghoff: “When a store has a 20% rate of return and the cost of capital is 10%, that’s a pretty good spread.”
Roellinghoff would probably be a diplomat like his dad were it not for a love of stereos. He dropped out of university to take a job at an Atlantic Video & Sound store in Ottawa, moved up into management, and later oversaw Anjou, Quebec- based Aventure Electronique Inc.’s expansion into Ontario. In 1996, he started his own business, selling tech products over the Internet and through direct mail. It was a short-lived venture, but among its lessons was the danger of thinking too small. “I would approach venture capitalists for a couple of hundred thousand dollars,” he says, “and for most, that’s just not worth their time.”
What he learned about raising money, however, proved invaluable when, in 1998, Venator Group hired him to run its Woolworth division, newly rechristened the Bargain Shop to move it down market and away from direct competition with Wal-Mart. Venator was itself the new moniker of struggling F.W. Woolworth Co., which was shifting away from general merchandise. (In 2001, Venator changed its name again to reflect its one remaining retail business, Foot Locker Inc.) It wasn’t a fun time to be in discount retail. Four years earlier, Venator had welcomed Wal-Mart to Canada by selling it 122 Woolco stores. Among existing discount chains, merger dalliances and internal squabbles diverted attention from fixing weak business models.
Roellinghoff’s plan to shrink and force discipline on the 128-store chain was just getting off the ground when Venator decided it wanted out, and told him to find a buyer. He winces when he recalls those months, working to maintain morale among staffers who could lose their jobs if he succeeded. “I couldn’t think of anything to do but be very honest with people about what was going on,” he says. Meanwhile, rivals were traipsing in and rifling through internal documents. Roellinghoff remembers BiWay CEO Abe Fish visiting a Bargain Shop location and saying, “You’ve got a nice store here, but all this has to go,” motioning to most of the merchandise. “I knew then it wasn’t going to be a fruitful discussion,” Roellinghoff says.
When a strategic partner didn’t materialize, Venator asked him to find investors to take the chain private. That was August, 1999. “And they said, ‘Oh, by the way, if you don’t have a deal in place by October, we’ll start liquidating the chain.’” He pulled it off, enticing a group of American investors who, along with himself and two other executives, bought out Venator. Although they kept only the 85 best-performing stores (few of which turned out to be in and around cities), most observers were doubtful about the chain’s prospects. “The balance sheet was quite transparent, gauzy,” Roellinghoff recalls, pretending to dangle a thin sheet of paper between two fingers. Unlike these days, when private equity firms are ready with open chequebooks, capital then was both scarce and expensive. The company refinanced in 2003, but by 2006, with the store count back up to around 150, Roellinghoff wanted “a more mature partner,” one with pockets deep enough to significantly ramp up growth. This time, when Bargain Shop put itself up for sale, eight bidders jostled to buy it.
Roellinghoff admits that Bargain Shop’s retail formula—low prices, convenient locations, a tightly edited assortment of department-store-quality goods—is ultimately not very different from that of its competitors. Some, like Giant Tiger, emphasize trendy clothing, while others devote more space to food or invest in displays. But in the business of bargains, the edge usually comes down to efficiency of execution. Roellinghoff draws a parallel to the hospitality business: “There are many Italian restaurants—it’s the subtle interpretations that determine if customers will come back.”
The special sauce in Bargain Shop’s operation is its sourcing strategy. While the company stocks seasonal merchandise and products that can be replenished regularly, “opportunity buys” on manufacturers’ end-of-line sell-offs or retailers’ cancelled orders generate the best deals. Say, a month before Easter, a vendor is sitting on 10% more inventory than he’d planned. He’d call a Bargain Shop buyer: “We have 600 cases of this Easter bunny. Normal cost: $1.10; we’ll do it for 90 cents.” Bargain Shop might take it right there, or it might wait for an even better deal as Easter nears. It’s the Winners or Costco model, but at a lower end of the market and modified to smaller volume. At the same time, “we don’t miss a trend,” says Andrew White, vice-president of merchandising and marketing. “If an item’s hot, we’ll book it like a traditional retailer. But while a department store plans six months in advance, we flow in opportunity buys throughout the season.”
The chain’s management savvy hasn’t escaped the notice of investors and competitors. Several people familiar with the chain’s sale last year said the top team’s deep retail experience and sophisticated read of the market was a key draw. Roellinghoff isn’t a visionary but a sharp operating guy—a more important quality in this sector. Merchandising-whiz White has been in the business for 28 years, including 4 1/2 years at BiWay, while Greg Wigle, vice-president of operations, has already spent more than a decade at Bargain Shop and its predecessor. The company has invested heavily in technology and market research to better track logistics and customer demographics, yet it keeps costs at every new store tightly reined in, spending, by Roellinghoff’s estimate, roughly one-third per square foot what its competitors do. Since Roellinghoff took over, margins have grown from the mid-20% range to the mid-30s, and revenues are reportedly on track to break $300 million this year. Jeffrey York, president of Giant Tiger, says the easy availability of capital has kept some poorly managed operators alive, but Bargain Shop is in a different league. “There is a real business model there. You just need a lot of stores to keep [the revenues] growing.”
Roellinghoff’s black BMW coupe is polished to a high gloss as we load in for a trip to tour some stores. He likes to drive—a good thing, since he spends a third of his time on the road visiting his own locations and those of his rivals, often lurking by the checkout counters to see what’s going through. As we enter the Bargain Shop in Waterdown, Ontario, on the outskirts of the Greater Toronto Area, “Hi, Michael!” resounds from several directions. “Mike” to his head office colleagues, Roellinghoff inspires a kind of respectful affection among store staffers (maybe it’s his height). “He doesn’t behave like a big shot,” says one store manager who attended the Belleville opening and greeted Roellinghoff with a firm handshake. “I train the girls to do the same,” she tells me later. “It’s professional, and I think he appreciates that.”
At 8,500 square feet, the Waterdown store is smaller than average but sports the new Bargain Shop look. It’s not busy, so we stop to greet Susan in the footwear section. Roellinghoff grabs the opportunity to show off the staff’s customer-service training, and asks if she knows “the non-negotiables.” Looking embarrassed, she rhymes them off: smile, make eye contact, ask if the customer found everything she was looking for, and thank her for shopping at Bargain Shop.
The store’s manager does monthly checks of designated competitors to make sure Bargain Shop is not under priced—offering the lowest prices is a key marketing promise—but Roellinghoff says that prices tend to level out over time. “Companies in the extreme-value sector, we watch each other like hawks,” he says. To meet its commitment to low price, the chain is often forced to sell below cost. “I look at flyers from five years ago and say to myself, ‘We’re so stupid! We constantly outbid one another,’” he says as we drive back to the office. “The price of a can of Coke today is the same or lower than it was then!” To take the edge off the uncharacteristic flash of passion, he cracks the old retailing joke: “I’m selling below cost, but I’m making it up in volume.”
Suddenly, he pauses. “Ay-yay-yay.” We’re driving by the construction site for a new shopping centre. A sign announces Zellers coming soon. “Another punch,” he sighs. It’s one aspect of the curious dance between small and large discounters that the best place for a store is either miles away from a big-box rival—or right next door. In fact, outlets located beside Wal-Marts do excellent business, says Roellinghoff. “Traffic beats competition.” A large store acts like a magnet for shoppers, and one way to adapt when a giant settles in is to hug it tightly. Unfortunately, in Waterdown, Bargain Shop will be 10 minutes from Zellers. It’s far away, notes Roellinghoff, but it may not be far enough.
In the process of adapting to shifting market dynamics, Bargain Shop has, at times, closed stores when sales failed to live up to expectations. The site-location formula is more complex than the 10,000 people/10,000-square-foot sweet spot: Some small communities support multiple discount merchants, while, elsewhere, residents continue to make the half-hour drive to Wal-Mart even when a convenient alternative arrives. Roellinghoff estimates there are 600 markets that, on paper, could welcome one of his stores, or a rival’s. Pinpointing the best bets will be a key competitive edge. For example, right now, Quebec is virgin territory for his chain, but that will change, he says. “When we move into Quebec, it will be a comprehensive approach because of the additional overhead cost of running a bilingual business.” That means at least a 10-store stake, he says.
The sector is healthy enough that Roellinghoff doesn’t expect a major consolidation, but he predicts that in the next few years, one chain could emerge as dominant nationally. “As the business model has matured in terms of figuring out how to make money in a Wal-Mart world, there’s an opportunity,” says Roellinghoff. “Those players who weren’t able to do that are falling by the wayside, and those who have an offering that makes sense are thriving.” Bargain Shop has a good shot if Genuity’s leverage helps it grow its geographic reach and purchasing power. He points out that Woolworth was once the Wal-Mart of retail: When Frank Woolworth started spreading his five-and-dimes throughout small-town America, he eventually made the local department stores obsolete. The Bargain Shop, Woolworth’s heir, may not unseat Wal-Mart, but could it topple Giant Tiger? Why not? “The important thing,” says Roellinghoff, “is to keep thinking like the underdog.”