Convenience Stores: and then there were three

Convenience stores seem to go from strength to strength. This year will set another new record for the number of new stores added to the three largest chains alone – and these three already account for some 75% of the entire market. With saturation point reached, the sector is now looking to the next step, with all three of the largest chains trying out new strategies for the day, very soon, when adding yet another 1,000 stores a year simply isn’t viable. As part of this, Seven Eleven could become the hub for sales of everything from nappies to high end fashions.

CHARTS

Chart 1: Leading Convenience Store Chains, FY2013: Sales, Stores, Share, and Sales per Store

Chart 2: Performance of leading chains, 2000-2013

Chart 3: Top Convenience store chains by Prefecture, August 2014

Japan’s convenience store (CVS) sector continues its mad dash to a fast approaching finish line. Various estimates of store numbers suggest the sector now has between 52,000 and 55,000 shops. It has grown out of the decline of Japan’s independent retail sector, with major franchise chains taking over existing “mom & pop” locations and turning them into branded, automaton-like chain stores.

While about half of current stores remain independent franchisees, in practical terms their independence stops at ownership, responsibility for income, and arranging work rosters of part-timers to run a store 24-7. A growing proportion of franchisees are corporate entities operating multiple stores and even hybrids with other formats such as supermarkets or drugstores. No matter what the business model, the number of viable locations is drying up fast and, while the major chains continue to up the pace of new store rollouts with thousands of stores added every year, there is a limit to how many more convenience stores Japan can support.

This situation is leading all the major chains to look for ways to diversify and better leverage existing outlets. For Seven Eleven, the main aim is to develop genuine omnichannel retailing, using its store network to supply and maintain a new, integrated online store. Lawson, meanwhile, is shifting strongly towards small format supermarkets, representing a threat even to Aeon’s ambitions in the same area. Familymart, while still pinning its hopes on international expansion despite recent setbacks, also continues to diversify from the core CVS format and is establishing a growing number of joint ventures with other retailers, notably in drugstores and supermarkets. There are some other chains (the table below lists 23), but these three account for a huge proportion of the total market and are the only chains showing any real growth potential. As the format becomes further saturated, other chains look increasingly uncomfortable and a major shakeout is likely sooner rather than later.

Store expansion remains the name of the game

CVS retailing continues to lead all other formats by growth. In FY2013, the leading 23 firms recorded sales of ¥9.88 trillion, now roughly a third larger than department stores, with only chain stores larger still. Sales increased 4.5% last year, although METI estimates the like for like figure was down 1.2% – both statistics outperform retailing overall, with the 1.8% increase in department store like for like sales probably no more than a blip. Sales at CVS chains have risen for 17 consecutive months and like for like sales also increased in five of the first eight months of this year.

Growth is clearly being driven by store expansion. Overall a net 2,859 stores were opened in FY2013, and METI figures suggest a further 1,460 were opened in 1Q2014 alone. All of the three largest chains plan to set new records for store numbers yet again this year, planning in excess of 1,000 stores each for a total target of 4,300 new stores this year. With store closures likely to be a little lower than last year, the sector as a whole should easily break 55,000.

This means the peak number of stores should stall just below 60,000. Seven Eleven, already a clear leader with more than 38% of the entire market, is the one chain still able to continue to expand at the same rapid pace for a little longer, at least until it smothers the final four prefectures where it is yet to open stores. While Okinawa might well end up the one prefecture that Seven Eleven disregards, it opened its first stores on Shikoku in 2013, adding 170 stores to Kagawa and Tokushima Prefectures in the first 12 months. The first Seven Eleven in Ehime opened early this year and Kochi has just been told it will get its first early in 2015. Competitors are already scrambling to keep up. This kind of organic expansion will continue to be Seven Eleven’s main operational focus in the short-term, supporting its more ambitious goal of omnichannel retailing in the medium term.

In contrast, Lawson will increasingly expand not into CVS formats, but into supermarkets. The Lawson Mart format, which debuted in February, is about 200 sqm – double the standard CVS, with plenty of room for Lawson’s growing direct sourcing operation for fresh produce. The acquisition of Seijo Ishii, the country’s leading upscale supermarket chain, will play a major part in this expansion. The Lawson CVS chain and the discount Lawson 100 stores will also take on a very different merchandise profile to what is currently available and to what its competitors offer. In FY2013, Lawson added the lowest number of new CVS outlets of all the big companies, allowing Familymart to partly close the gap, but it expanded more in other formats, so the number is misleading.

Familymart remains more difficult to read. The chain’s priority appears to continue to be overseas expansion, where it has been comparatively successful since Itochu, its trading company owner, took over in 1999. At home, Familymart added far more stores than Lawson last year, finishing just 1,000 stores behind and overtaking Lawson in Tokyo where it remains only 300 stores behind Seven Eleven. Familymart also has higher overall sales per store per day compared to Lawson. Around 600 stores and ¥150 billion in sales come from regional franchisees in Hokkaido, South Kyushu and Okinawa (‘Area Franchisees’ in Japanese parlance). These have been outperforming the central operation, with Hokkaido Familymart up 14.4% last year for example – although it did increase store numbers by 17% to 68. These regional sub-chains are arguably enjoying the last chance of success before its two larger, directly run rivals expand there further. Like Lawson, Familymart also wants to diversify formats, but its preference for joint venture relationships means it is cherry picking agreements where available and could easily end up with an unwieldy group of operations. It has around a dozen drugstore ventures in place and negotiations with JA to incorporate the A-Coop supermarket chain are also ongoing.

The other chains fall into two groups. There are a small number of chains that continue to hold their own, due to either regional or format specialisation, for example Seicomart in Hokkaido or the various railway operated chains like Hankyu’s Heart In. The second group have no such USP and are under increasing pressure. Even Circle K Sunkus, the number four chain, is struggling outside its stronghold in Chubu. Two of its major regional franchisees switched to one of the larger competitors last year, and it now has just one remaining in West Shikoku. Even this is under threat. Seven Eleven’s rollout on the island has hit sales at other chains hard. In October, Three F’s Shikoku regional franchisee, Sunnymart, threw in the towel, pulling out of its deal with the ninth ranked chain. It is now talking to Lawson, currently the largest operator on the island, about switching its 83 stores to the new banner.

Although the sector is no longer as uniform as it once was, all the major companies are dealing with a number of similar issues and initiatives, of which store expansion and format diversification is just one. The other main issues are:

Private brand and merchandise differentiation

Omnichannel retailing with CVS stores as a hub

International expansion

Private Brands and Merchandise

The CVS sector made direct control of logistics a key priority from early on, providing ample opportunity to work with – and occasionally against – suppliers to develop exclusive product ranges. Seven Eleven has long touted figures of 50-60% of sales from exclusive items, but it introduced its own label private brands only six years ago. Today, the chain is rapidly expanding products carrying its own branding, with an estimated 35% of sales from its own brands. Having been freed from supplier expectations of complete control over product branding, all CVS chains are now following the same policy, and with their cutting edge information systems and new, purchase tracking loyalty cards, the potential for development of unique new products based on customer data is genuinely huge.

This trend alone might push the CVS format even further away from, and probably ahead of, supermarkets as consumers’ preferred place to buy foods – although equally, in Tokyo there seems to be something of a backlash as supermarkets get their act together and offer better priced, healthier alternatives in equally convenient locations (see Page 8). Even so, in the food sector, convenience stores are the only retailers likely to achieve the holy grail of selling product branded with the store name. In food at least no other format has even attempted to achieve the ultimate goal of selling product branded with the store name.

At present, all the leading 10 chains produce their own branded chilled desserts, lunch boxes, and daily foods like breads and milk. Beginning only last year, when Seven Eleven first introduced the idea, the top 10 chains now also offer instant drip coffee too. An amazing 700 million cups of CVS branded coffee were sold last year, Seven Eleven accounting for 85%. The big chains are introducing a stream of new ranges of breads, especially donuts, and desserts designed to complement the coffee too – Lawson even offers ‘low sugar’ versions to maintain its claim as the healthiest of the three.

While Seven Eleven continues to expand its ranges of own-branded packaged foods and snacks, Lawson is looking for ways to differentiate once again. It has introduced in-store prepared rice balls and sandwiches at 5,000 of its stores. Prices and margins are higher for in-store prepared products, but the freshly made items are proving popular. A few chains, notably Three F, have even introduced in-store bakeries, although most analysts are dubious about the economics given the premium on space.

Similarly, both Familymart and Circle K Sunkus (CKS) have begun to take this one step further by opening in-store eating areas, usually on the second floor. Aeon’s much smaller Ministop chain has always included a small eat-in corner in almost all its stores, but the newer stores take this to a whole new level. The additional cost of space and service means that it is a format extension that can only be applied in well chosen locations.

The impact of all these developments on suppliers is significant. With private brand ranges expanding, and CVS making up such a major volume share for many processed foods, notably drinks, confectionary and desserts, manufacturers are falling over themselves to offer something new – and a new product launch that doesn’t appear in one of the top two chains is more likely to fail than succeed. Canny manufacturers are ingratiating themselves with lower wholesale prices, even selling at a loss for some launches, as well as offering their own unique products that the CVS chains can sell for higher margins. Some smaller, regional manufacturers have cleverly come up with new products designed just for local chains, such as an octopus rice dish in Okinawa.

A recent example of this was the launch of New Zealand juice brand Charlie’s (see Page 3). Charlie’s was acquired by Asahi Beverages in 2011 and is the first example of Asahi bringing an overseas acquired brand into Japan. The product’s premium nature as the first non-concentrate juice, and tried and tested branding, meant Seven Eleven leapt at the chance to take it on for an initial one year exclusive deal.

Since the April tax increase, some second tier chains, notably CKS, have also implemented fairly large scale coupon discount campaigns negotiated with suppliers to try to keep customers coming. Larger chains have avoided price cuts, not surprisingly. Seven Eleven even continues to score hits with premium own brand lines. Lawson and Familymart have preferred to tweak their loyalty card rewards, offering more points for higher purchase rates and more special promotions to card holders. All the leading chains are also offering promotions through social media marketing too. Again, a lot of the costs of these campaigns have to be borne by suppliers when it’s a manufacturer label on offer. Further pressure on supplier prices and contributions to marketing are likely as private brands take ever greater share of sales.

Omnichannel Strategy

Seven & I plans to become an advanced omnichannel retailer, integrating its entire set of retail assets to allow customers to buy any of its 5 million or so SKUs online at any time. Naturally, in the short term at least, Seven Eleven will use its first-class IT and logistics systems as an integral part of this strategy, with customers encouraged and sometimes required to pick up and even pay for online purchases at their local CVS.

This does more than just help extend the scope of Seven Eleven stores. The three deliveries a day made to each of the 17,000 Seven Eleven stores come from a network of dedicated distribution centres that provide the opportunity for same-day delivery, not just for Tokyo and Osaka, but for the entire country. Add in the new DCs that provide supply of lower turnover products, new in-house delivery capacity from the acquisition of Nissen, and major third-party partners such as Tohan for books and magazines, and Seven Eleven could well have a model that easily rivals Amazon. Delivery costs can also be cut to a fraction of those currently charged by the big parcel delivery firms. Nationwide free shipping on all 5 million SKUs could become a reality and provide the first real local response to Amazon’s so far unsurpassed service.

The omnichannel is currently in its first stages of development. Seven Eleven introduced tablet terminals at stores in Kansai, Chugoku and northern Kyushu in the summer, allowing customers to order from Tohan’s stock of 1 million books and magazines sold through Seven Net Shopping for delivery to the same store within 24-hours – demonstrating ongoing efforts to resist digital publications by Japanese publishers as much as Seven Eleven’s role at the centre of Seven & I’s omnichannel strategy.

Since May, customers have also been able to order a limited range of products from Loft and Akachan Honpo for delivery to their local Seven Eleven. By mid-2015 it plans to complete integration of the entire group, including Sogo Seibu department stores and new acquisitions Barneys and Bals, with delivery to 7,000 Seven Eleven stores nationwide in the initial stage. A new distribution centre dedicated entirely to online orders and carrying products from across the group opened in Saitama in late October. The centre already offers delivery to your nearest Seven Eleven store in Tokyo by 7pm for orders made before 7am, and orders made the previous evening can be picked up from a local Seven Eleven on the way to work if required. There’s no additional delivery fee and customers can make product returns directly to the same store.

By mid-2015 the whole system will have 3 million SKUs available for sale online.

No one underestimates the power of Seven Eleven in the food channel, but with this omnichannel strategy, the country’s leading retail chain will soon become a potential competitor in other categories too, even in apparel. Time will tell how well it manages to encourage shoppers to buy fashion items through the same system, but the literal convenience it offers could well be compelling to many, especially busy singles and those living in the regions. In FY2013, Seven & I’s online sales were just ¥150 billion, but it is targeting ¥1 trillion in online sales by 2020. Even with total e-commerce (goods only) growing at 17.4% last year to ¥11.2 trillion and set to maintain this pace, this will still be a significant share if Seven & I hits its target.

The other big names are keen to use the same tactic to extend their stores, but none have Seven Eleven’s ambition. Until now, Lawson had preferred to sell digital products, but as JC went to press it announced a new deal to allow customers to order Amazon’s full range of products – effectively beating Seven Eleven to the punch. In addition to opting to pick up Amazon purchases in Lawson stores, standard terminals in Lawson allow anyone, even without a credit card, to order from Amazon. Delivery is made within two days. The new scheme launched in 500 stores in Shizuoka on 5 November and will rollout nationwide over the next 12 months.

In addition, Lawson is again pushing its claim as the ‘healthy’ CVS chain, tying with Renaissance, a major operator of fitness clubs. The venture offers a smartphone app that tracks various health and exercise statistics and recommends which Lawson products would best fit dietary and fitness aims. It has similar deals with USEN, a cable radio provider, to sell popular songs through Lawson HMV’s online site.

For smaller chains, the opportunities to compete online are limited. Even though CVS chains rely on relatively good IT systems and data collection, few can match even a fraction of the ¥100 billion Seven Eleven will invest in the medium term to get its omnichannel working. Of the 23 main CVS companies, last year 11 had mailing lists and offered in-store wifi, but only eight were using social networks in their marketing and just six sold any product online. None of the others had plans to implement these features either.

International Strategy

With so much going on at home, international strategy gets less coverage, but all the CVS chains are active outside Japan. At the end of FY2013, the four chains of Seven Eleven Japan (excluding country licences), Lawson, Familymart and Ministop operated 52,067 stores offshore, a 3.9% increase on the year. While this allows the big firms to add volume and to leverage both their brands and supply networks, overseas chains are significantly less profitable than those at home.

Seven Eleven Japan runs major store networks in the USA, Thailand, Korea and parts of China. It also plans to open in Dubai in 2015. Including licensed operations, the total Seven Eleven network worldwide includes some 53,000 stores.

Lawson and Familymart have newer, more directly operated businesses, although these too usually rely on local country partners. Lawson has been slowest of the big three in expanding overseas having had a hard time at its Shanghai operation and, reasonably, preferring to concentrate on repositioning its domestic operations. From last year, it has turned its attention to other parts of Asia, opening its first store in the Philippines and hoping for 500 stores there by 2020. Indonesia and India are also being investigated.

Familymart pulled out of its joint venture operating a 7,000 store chain in South Korea in the Spring. Until then it had more stores overseas than at home, and international expansion was its main priority. That may have changed, but it does plan to grow significantly in China. Reports suggest that the Chinese operation made a profit for the first time in 2H2013, and it is forecasting its first full year profit there this year. It will also now rapidly expand the franchise model, allowing for better margins. At present, only a third of Familymarts in China operate as franchisees, but having established the brand and with the market becoming more transparent and efficient, it now plans to expand franchisees to 60%.

It will also add 300 stores in China this year, taking the total to 1,300, expanding into eight new territories. By 2020, it plans to have 5,000 stores in the country, of a total overseas chain of around 18,000 stores – up from around 5,000 at present, although Familymart’s various press releases often seem to forget the Korea debacle, quoting the same 11,000 overseas stores that were operating in February 2012, so final target figures may change. It is targeting Indonesia, Vietnam, Laos and Cambodia as major areas for expansion as well.

No longer one standard fits all

With store expansion as the prime growth strategy now increasingly tricky, at least at home, the days of a homogenous CVS sector are fast coming to a close. In the past the relentless pace of expansion meant all capital resources and indeed management vision was used to plough into new territories as fast as competitors. This race is almost over, with Seven Eleven the clear winner. It alone can survive without adjusting its core concept, but even then it could see significant increases in footfall and further expand its role as the local community store thanks to Seven & I’s omnichannel strategy.

The other two chains – and let’s be honest, there are only two more of any importance – have had no choice but to look beyond CVS retailing for ways to compete, both with Seven Eleven and the growing threat from small store supermarket chains from the likes of Aeon. Lawson, with Mitsubishi’s help, has executed brilliantly on this, and has created distinct, compelling hybrid stores mixing the best of CVS and supermarket retailing. These new chains stand Lawson in good stead and make it a promising partner for suppliers as it expands its merchandise ranges to fit its larger stores.

Familymart’s future is less certain given its hesitant expansion beyond the core CVS format and competition. Even overseas the debacle in Korea was a significant setback and it will face competition in Asia from both Japanese competitors and local rivals. Its fortunes are, however, considerably brighter than Circle K Sunkus. Itochu, which controls Familymart and is lead partner to Uny, CKS’s parent, must be wondering just when, not ‘if’, it can arrange a merger of the two chains. Doing so may or may not solve the weaknesses in both chains, but would provide enough volume to worry even Seven Eleven and perhaps prolong the standard convenience store expansion wars just a little bit longer.