Selling Services to 'Pet Parents' Fetches Comeback for PetSmart

October 10, 2007

When PetSmart decided to create a rewards card, the company rejected the model used by grocery stores and other retailers and decided to pattern its customer loyalty program after Harrah's Entertainment, the casino operator.


The idea behind the program is to compile data on customers and use it to attempt to modify their behavior, PetSmart chairman and CEO Philip L. Francis told the W. P. Carey School's Economic Club of Phoenix Oct. 9.


Francis has been in retail for 35 years and before becoming CEO of PetSmart in 1998, he was president and chief operating officer of Shaw's Supermarkets, based in Massachusetts.


"I am a recovered grocer," he said. "And I think one of the great tragedies is the way the grocers have failed, while spending 3 percent of sales for the last 30 years, to manage either their margins or their pricing pressure with pricing via the card."


Not only did Francis feel the traditional retail loyalty programs worked poorly for the grocery industry, pricing and margins were not areas where Phoenix-based PetSmart needed help, he said.


PetSmart started its rewards program in 2003, coming late to the party because of other problems with the company. That gave the nation's No.1 pet specialty retailer the opportunity to scout other programs.


"With love in our hearts, we rejected every grocer or retailer we saw," Francis said.


What the PetSmart top managers liked was Harrah's, which operates more than 30 casinos worldwide.


Harrah's broke the mold in the gaming industry, trying to make good customers better by using information it gleaned from its Total Rewards Card. The traditional tactic had been to go after high rollers.


"You find John and Ethel from Enid, Oklahoma who visited the casino twice last year and figure out how you can get them to come three times this year," Francis said.


Harrah's current CEO Gary Loveman, hired as chief operating officer from the Harvard Business School faculty in 1998, pioneered the concept. Loveman took a mountain of transactional data Harrah's already compiled and used it to tailor inducements.


Harrah's isn't the only company to make better use of its loyalty program. U.K.- based grocer Tesco, which is about to make its first foray into the United States, uses loyalty card data to help with market research and product launches.


PetSmart's system divides customers into 10 slots, based on spending habits. Most of the emphasis is on the third through seventh slots. An example would be a dog owner who buys premium food at PetSmart but who doesn't have the animal groomed there. PetSmart sends that customer a coupon for a free bath.


"The variable cost of delivering a free bath Monday through Friday is probably three bucks," Francis said. The customer need only bring the dog in once more for a bath or grooming to make it a profitable inducement.


Turning the company around


The customer loyalty program is just part of PetSmart's turnaround from its nadir in December 2000 when the stock price fell below $2.50 a share. In the fall of 2007, the stock was trading in the $30 to $35 range.


The day after Francis spoke at the Economic Club, the company revised its forecast for the third quarter, lowering third quarter earnings estimates to $0.17 to $0.20 per share, down from $0.21 to $0.23.


Francis told analysts that the company was feeling some of the pressures from a slowdown in discretionary spending by consumers that has affected other retailers. Most of the slowdown was in hard goods, such as leashes and beds.


Founded in the late 1980s as PetFood Warehouse, PetSmart was designed to be a category killer with dominant prices and dominant variety. The concept worked well. Starting with two warehouse stores in Arizona, the company grew steadily and went public in 1993. The next year the chain opened its 100th store.


But by the late 1990s the company was losing steam. "The business model didn't become wrong, but it wore out," said Francis, who joined the company as an outside director in 1989. In 1998, he took over as CEO in an attempt to turn the firm around.


"I ran it through the car wash, changed the sparkplugs and nothing good happened," he said. "I realized that even well-intentioned, well-informed outside board members don't know nearly as much as management."


The company finished 2000 in the red, but there were already signs of a turnaround.


The pet services side of the business grew at an annual rate of 21 percent -- the first of six straight years of 20 percent or better growth in services. Services are about twice as profitable as retail for PetSmart, Francis said.


That year, PetSmart bought PetsHotel Plus, a pet boarding facility in Tucson. PetsHotels have been a bigger winner for the company.


"We had a couple hotels that last year in the last week of December had 400-dog waiting lists," Francis said.


It's a high-margin business that no competitor can duplicate. "We have an extreme cost of capital advantage," Francis said. In new stores, the company can add a hotel for about $1 million. It can retrofit a hotel for $1.5 million. He said it would cost $2.5 million for a similar, free-standing facility.


"Because we bolted in or bolted on, we already have the parking lots there, and the staff break rooms are there and the air conditioning's there and the heat's there and computer systems already there," he said.


In 2000, the chain tested and began building a new store model that no longer resembled a warehouse.


Riding the wave


Since then, PetSmart has ridden high on pet parenting, a trend where adults, often childless, treat companion animals much like children. The American Pet Products

Manufacturers Association's pet ownership survey shows 63 percent of U.S. households own a pet, up from 56 percent in 1988. The trade group estimates Americans will spend $40.8 billion on pet-related products and services.


The 'humanization of pets' is good for business. "We're on the front edge of it," Francis said. "We're in the middle of it. We can influence it a bit."


PetSmart is seeing the number of pets and the amount spent per pet rising, Francis said.


Since 2000, PetSmart's annual revenue has doubled to $4.23 billion in 2006. And there's room to grow.


At the end of the second quarter, PetSmart had more than 966 stores in North America, and the company said in filings that the saturation point was about 1,800 stores. Although PetSmart is the clear leader in pet retail, its share is only 13 percent of the market. Its closest competitor is Petco with about 6 percent.


In services, PetSmart has about 11 percent of the market and is the only national player.


The total number of households that own a horse increased by 2.4 percent to 4.3 million households from 4.2 million households in 2006, according to the American Pet Products Manufacturers Association's survey. But PetSmart decided to get out of the equine business and concentrate on animals that can stay inside the house.


Even among house pets, the dog is king for PetSmart, which Francis refers to as a "dog-centric business."


Although the pet parenting movement is international, PetSmart has no footprint outside North America. PetSmart had a presence in the United Kingdom in the mid-1990s, buying Pet City Holdings, which was the nation's largest pet specialty retailer with 57 locations.


But Francis said the company's approach was somewhat arrogant. "Not a good way to start," he said. PetSmart sold off its United Kingdom holdings in 1999. When the company ventures outside North America again, it will probably partner with a local company, he said.


Bottom Line:


  • PetSmart's customer loyalty program is modeled after the program at Harrah's Entertainment rather than another retailer. The program is designed to turn good customers into better ones rather than for improving pricing and margins.
  • Pet products and services are a fast-growing $40.8 billion business in which PetSmart leads in both categories. But the market is highly fragmented without dominant national players in either retail or services.
  • The driving force behind growth in the pet industry is the pet parent trend, where adults treat animals as though they were their children. It is an international phenomenon.