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Soft Drinks Price Cut Hard to Swallow for Seven-Eleven's Rivals

10, 20. 2005

   In the first part of September 2005, Japan's leading convenience-store operator Seven-Eleven Japan Co., Ltd. cut prices on its soft drinks, its mainstay product. A fixed pricing system has long helped convenience stores keep profitability at high levels. Seven-Eleven's measure was prompted by weakening performance across the sector, which has raised the specter of a shakeout.

   Seven-Eleven has made cuts from 147 yen to 125 yen, on seven categories of soft drink sold in 500ml PET bottles. The same products are sold at between 90 yen and 110 yen at supermarkets and drugstores. With convenience stores charging nearly 50% more, customers felt they were overpriced.

Convenience stores: Overall sales, and year-on-year change in salee per customer

   Seven-Eleven is the giant among convenience-store chains in Japan. In fiscal 2004, sales at its stores totaled 2.4 trillion yen, making it the foremost Japanese retailer (non-consolidated basis). With an OP margin in the year of 34%, it has a reputation as a highly profitable company. On September 1, it established a holding company with group affiliates Ito-Yokado (general merchandise stores) and Denny's Japan (restaurants), enabling it to integrate its management.

Slowdown Afflicts Sector

   Seven-Eleven's action is a response to weakening performance at convenience-store operators. Even the star of the sector has seen sales fall below year-earlier levels at established stores for five consecutive terms since 2000. The reason is intensified competition from retailers outside the sector, such as supermarkets, which now operate deeper into the night, and drugstores. More recently, competition has come from the Shop 99 chain, which sells everything from fresh food to daily miscellaneous items at a flat price of 99 yen. The convenience stores have lost their monopoly on the attribute they are named for, 24-hour convenience.
   Soft drinks are the mainstay items sold at convenience stores, followed by boxed lunches and ready meals. With convenience-store operations (franchise stores and Seven-Eleven headquarters) achieving a gross margin of nearly 40%, they are a powerful earnings driver. But, says an official of a rival convenience-store operator, Seven-Eleven's soft drink sales began to falter in the latter half of last year.
   Convenience stores retain their edge in categories where a high proportion of products are original, such boxed lunches, but they are struggling in those where nationally known brands predominate, because customers feel they are too expensive. Seven-Eleven now seems to be considering similar price cuts on processed foods, where the big brands have a strong presence.

Smaller Convenience Store Chains Feel the Heat

   Seven-Eleven will now focus on negotiating lower prices from its suppliers. Here, it has gained leverage from the establishment of the holding company Seven & I Holdings with Ito-Yokado. Some observers expect Ito-Yokado's overwhelming purchasing power to put Seven-Eleven in a strong position for bargaining with the manufacturers that supply the chain.
   In fact, price cuts are a more sensitive issue for convenience stores than for other retailers. Convenience stores use a "split" business model in which gross profit (difference between sales and cost of sales) is divided between franchise stores and the operator. In other words, if lower prices become the norm, franchise stores will suffer decreasing revenues. This will inevitably threaten the franchise system on which the convenience-store sector is founded.
   Only the big chains such as Seven-Eleven with their purchasing clout can ask suppliers to lower their prices. Mid-sized and smaller chains may get into difficulty if they cannot resist pressure for lower prices. If they do make cuts, profits at both franchisees and chain operator will fall. This could spark a shakeout in the industry.

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