For most retailers, a slowing economy characterized by inflation, unemployment and a lack of consumer confidence spells big trouble. But for at least one sector in the retail world, those aren't such bad signs. Although they haven't been completely immune to the slowdown, dollar stores have been a bright spot, reporting rising sales throughout 2008. More importantly, major dollar store operators are planning store openings for well into 2009 even while other chains are pulling back on expansion.

Although most retailers in August and September reported disappointing same-store sales or sales at stores open at least a year, dollar stores reported gains. At Matthews, N.C.-based Family Dollar Stores Inc., for example, same-store sales jumped 3.6 percent in August and 5.6 percent in September. According to Columbus, Ohio-based research firm TNS Retail Forward, same-store sales across all retailers — including discounters like Family Dollar and Target Corp. but leaving out gas stations, cars and restaurants — rose just 2 percent during August. In September, same-store sales rose just one percent, according to ICSC.

Profits for dollar stores have also been growing more than at the traditional and luxury retailers as more consumers look for value to combat high gas prices. Chesapeake, Va.-based Dollar Tree Inc. posted a second-quarter profit gain of 15 percent, largely due to a rise in same-store sales of 6.5 percent and a boost in overall sales of nearly 13 percent during the period. “Our performance in the second quarter demonstrates the growing relevance of Dollar Tree to the consumer during tough economic times,” said CEO Bob Sasser in a statement when the company announced the results late in August.

Meanwhile, mall and other higher-end retailers have struggled. Saks Inc., for example, reported a deeper loss in its second quarter and said it was now seeing customers who typically buy designer labels cut back. Previously only customers who typically spend out of their price range — called “aspirational” shoppers — were slowing down on spending. New Albany, Ohio-based Abercrombie & Fitch Co. posted an 11 percent drop in same-store sales for August, even worse than the 7.9 percent decline most Wall Street analysts had expected, according to Thomson Reuters.

Challenges remain

But even though dollar stores are in many ways performing far better than their higher-priced peers, there are pockets of weakness. Clothing sales, for example, have been slow at stores like Family Dollar. Buckingham Research analyst John Zolidis says that may indicate that lower-income consumers are still being pressured by the economy. This is despite an infusion of cash in consumers' bank accounts earlier this year from the government, which issued economic stimulus checks to eligible taxpayers earning less than $75,000 or $150,000. That burst of money, however has faded. “We do not think customers are likely to start buying apparel in larger quantities at Family Dollar stores anytime soon,” he says.

And slower sales on some merchandise isn't the only headwind blowing in the face of dollar stores. Higher costs, which have affected virtually every retailer, have also been putting a dent in the profit line at dollar stores. Food costs have jumped to record levels in the past year, making it harder for dollar stores that sell food to make a profit.

Energy and labor costs also have climbed far higher due to rising oil and natural gas prices and increases in the federal minimum wage rate. There were signs of relief on all these fronts in September. The global commodities bubble seems to have been pricked, sending costs of staples down after months of unrelenting increases.

Regardless, the recent pullback has not undone most of the rises over the past year. Deutsche Bank analyst Mike Baker estimates that Commerce, Calif.-based 99 Cents Only Stores saw the minimum wage in California jump 7 percent in 2008 on top of an additional 11 percent increase in 2007.

With 70 percent of its stores located in the state, the increase had a noticeable effect on the company's bottom line. Similarly, on a conference call with analysts in July, Family Dollar CEO Howard Levine lamented the slowing consumer spending and the inflationary cost environment and their effects on his fellow retailers. “The pressures we face today are some of the strongest headwinds I've seen in my 25-plus years in retailing,” he said.

A strategy being used by at least one chain to help cover the costs is to boost the $1 price point so essential to the dollar-store format. 99 Cents Only Stores said earlier this month it would raise its prices to 99.99 cents in a bid to offset higher costs.

The move was mainly hailed by Wall Street since it had the potential to insulate the company's profits. CEO Eric Schiffer said the change was necessary due to “dramatically rising costs and inflation.” In a statement, Schiffer explained, “Just as Motel 6 was eventually forced to raise its price above $6, after 26 years we are forced to raise our price by just about one cent.”

Technically, it wasn't the first time the dollar retailer moved to boost prices, but it was perhaps the most noticeable to consumers. Last year, 99 Cents Only Stores lowered some prices below 99 cents, but consumers got less for their money. The company broke down multi-packs of products and charged consumers less for the pieces. In other words, instead of selling a six-pack of soda for 99 cents, the company priced a four-pack at 79 cents, in essence raising prices by 20 percent. Baker says although some consumers pushed back, “the net result to sales has been positive even with the price sensitivity.”

Competitor Dollar Tree is also testing offering products at higher price points while still keeping them lower than consumers would find at traditional retailers. The chain added a program called “Oops” to about 25 stores in select markets. Certain products are designated with graphics telling consumers that the product may not be $1 but the value was too good for the company to pass up.

Growing locations

At a Bank of America conference in September, Dollar Tree's Sasser said customer acceptance of some higher price points is “kind of mixed” currently. “We are selling some stuff, and it's interesting enough we are continuing to test it, but it's certainly not something…that we are ready to roll out,” he said.

If consumers continue to buy, that would give retailers all that much more room to spend on growing their store base. In an August conference call with analysts, Schiffer said the chain is working its way through a “controlled” new store expansion plan. The company has opened about 12 stores since the start of the year and expects to open another seven by year's end.

Schiffer said the chain will open 19 more stores in fiscal 2009, many in a smaller format of 14,000 to 20,000 square feet rather than the older 25,000- to 35,000-square-foot model. Schiffer did say the chain will also close a number of underperforming stores whose leases are coming due, but with many retailers curtailing all expansion plans for the time being — or cutting them well short of the original goal — the expansion planned for the rest of the year and 2009 is notable.

His competitors have also detailed plans to open more stores this year. Family Dollar plans to open 200 stores in total in 2008 and close just 75. It operates more than 6,500 stores in 44 states across the country from Maine south to Florida and west to Idaho and Arizona. 99 Cents Only has expanded to more than 277 stores since opening its first in 1982, with 193 in California, 48 in Texas, 24 in Arizona and 12 in Nevada.

However, in September, the company announced it will exit the Texas market and focus on its remaining 229 stores in its core markets where it derives 90 percent of the company's sales. For fiscal 2008, its total sales were $1.2 billion.

Meanwhile, Dollar Tree, which has more than 3,500 stores in the 48 contiguous states is expanding a new concept that offers low prices but gets rid of the $1 price ceiling called Deal$. The company is expanding the chain outside of its traditional home base in the Midwest and will wind up opening between 22 and 24 stores in 2008 and about the same number in 2009. “It will give us an opportunity to go into some of the more expensive real estate around these urban centers in the Northeast or in California or wherever they may be,” said Sasser at the September conference.

Certainly, as the economy weakens, dollar stores may expand. Consumers have an insatiable desire for value these days and for dollar stores, nothing could be a better catalyst for sales growth. “In today's economy I think people of all income levels are feeling very uncertain, and they're looking for solutions,” Schiffer said during the call. “I believe our store provides that.”