Like Cats and Dogs

By GEORGE WHITE

July 24, 1998 12 AM PT

TIMES STAFF WRITER

For pet supply superstores, it’s become a dog-eat-dog world.

Four years ago, analysts predicted that the two largest chains--Petsmart Inc. and Petco Animal Supplies Inc.--would quickly dominate an industry made up of small neighborhood pet shops, following a blueprint established by Toys R Us in the toy business.

But today, Petsmart and Petco are having problems. Neighborhood pet stores have proved more resilient than expected. And supermarkets and discount chains like Wal-Mart have moved aggressively into pet food--the biggest item sold by the superstores.

Analysts now doubt that the two big chains will come to dominate the $20-billion pet supplies business any time soon.

“The competitiveness of the industry was underrated,” said Jack Sweet, Irvine-based editor of the Pet Supplies Marketing Directory. “Petco and Petsmart are fine stores with competitive products, but they are not going to dominate. There’s room for all kinds of retailers.”

When Phoenix-based Petsmart pioneered the superstore business in 1987, the course seemed clear. Its warehouse-style stores offer low prices and a better selection than local pet stores. And it sells pet food for less than local pet stores and supermarkets, counting on other pet supplies like dog carriers, leashes and fish tanks for much of its profit.

Thanks to a rapid series of acquisitions, Petsmart now has 10% of the pet supplies business in the U.S., with 414 stores. It operates an additional 107 stores in Canada and Britain.

San Diego-based Petco started building superstores after Brian Devine, a former Toys R Us executive, became chief executive in1990. Under Devine, Petco followed Petsmart’s lead, with a twist--it specialized in costly premium pet foods. The company situated its stores near supermarkets to entice shoppers into Petco to buy their pet food.

Like Petsmart, Petco grew through acquisitions. From 1994 to 1997, sales grew annually by about 50%. Petco operates 459 stores in the United States and has 5% of the pet products business. (Its stores are smaller than Petsmart’s.)

The landscape began changing in 1994 when Wal-Mart introduced its own premium brand of pet food at a price that is substantially less than brand-name dog and cat foods.

Thanks to Wal-Mart, pet food sales at discounters are growing rapidly. Sales at discounters rose 16.3% over the last 12 months, according to Information Resources Inc., a Chicago-based firm that tracks product sales.

Supermarkets soon followed suit, introducing their own brands of pet food. The move was partly defensive--many supermarket shoppers had defected to discounters and the pet superstores. Supermarkets’ share of pet food sales plunged to 58% in 1996 from 95% in 1985. But those losses appear to be leveling off. Last year, supermarket sales of dog food rose nearly 1%, according to Information Resources. But the real surprise has been the staying power of the small independent pet stores, which were supposed to crumble in the wake of the big chain operations.

Neighborhood pet shops have the edge when it comes to pets. While superstores focus on small pets, such as birds, fish and lizards, the small stores sell dogs, cats and everything in between. Analysts say they underestimated the loyalty that pet buyers have to the stores where they purchased their pets.

These factors have taken a toll on the superstores. Two weeks ago, Petco predicted its sales would increase by only about 5% for the quarter that ends Aug. 1.

Petco also faulted itself for mishandling acquisitions, particularly in the Midwest. It had trouble quickly converting stores to its format, and it delayed advertising the stores--giving competitors an opportunity to steal business. Petco, with 100 stores in Southern California, says it plans to manage future acquisitions better.

Meanwhile, the company has launched a national advertising campaign that stresses its loyalty card and touts its high-end dog food brands and other products not available at supermarkets. The ads, part of an effort to reverse two years of losses, are aimed at people who now buy their dog food at supermarkets. Pet food accounts for 40% of Petco’s sales.

“We’ll stress that we offer products that you can’t find at grocery chains,” said Petco CEO Devine.

Petsmart, with 30 stores in Southern California, underwent a management shake-up last year. It brought in a new CEO--Philip Francis--who this year also assumed the duties of chief operating officer.

Hurt by discounters, the chain plans to improve its service to gain an edge. The company has initiated a training program for employees and has taken steps to manage its inventory better so employees spend less time tracking goods and more time on the sales floor.

Toward that end, Petsmart cut back on inventory--a move that caused it to reduce orders and lose some discounts from pet food suppliers. But the company isn’t passing higher costs on to customers because it fears driving them to discounters like Wal-Mart. Petsmart derives 48% of its sales from pet food.

Despite the challenges, Petsmart and Petco have some key advantages over competitors--a wider selection of merchandise and the convenience of many outlets compared with discounters and neighborhood pet shops, said Doug Gordon, an analyst at Nationsbanc Montgomery Securities in San Francisco. However, the manner in which they have achieved much of their size--acquisitions--has created some problems, he said.

“Store conversions can be difficult because the company is inheriting new employees who must be retrained,” Gordon said. “But Petsmart and Petco have formidable formats and they should iron out transition wrinkles.”

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Leaders of the Pack

Petsmart and Petco have generated hefty sales gains but have felt growing pains.

Revenue

Quarterly, in millions

Petsmart fiscal 4th qtr.: $510.6 million

Petco: $211.6 million

Earnings

Quarterly, in millions

Petco fiscal 4th qtr.: $5.3 million

Petsmart: $1.9 million

Sources: Bloomberg News, company reports