Discount retailer Family Dollar Stores (NYSE:FDO) seems to be imploding. The Matthews, N.C.-based discounter was already lagging rivals Dollar General (NYSE:DG), Dollar Tree, and Wal-Mart Stores (NYSE:WMT), and now it seems to have fallen into greater despair.

In trouble
Family Dollar's just-released first-quarter results were not pretty. Revenue increased just 3.2% to $2.5 billion, but net income was down to $78 million in the quarter from $80.3 million in the prior-year period. While these numbers might not suggest that Family Dollar is in a precarious position, a 2.8% drop in same-store sales and a tepid outlook for the current fiscal year will remove any doubts.

Moreover, Family Dollar's president and chief operating officer, Michael Bloom, resigned recently after what seems like a fallout with Howard Levine, the CEO. According to Levine, "While we've made some progress during Mike's tenure, we weren't happy with our financial results. Ultimately, Mike and I were not aligned on our merchandising strategy and we decided to make a change." 

While rival dollar stores have been seeing an increase in traffic, Family Dollar is going the opposite way. In its last-reported quarter, Dollar General's same-store sales grew 4.4%, while revenue and net income grew in double digits. Also, in what was considered to be a weak quarterly performance, Dollar Tree managed to post same-store sales growth of 3.1%. 

Family Dollar struggled as lower-income customers looked to stretch their budgets. According to The Wall Street Journal, more than 50% of Family Dollar's customers receive some kind of government assistance. But now, high unemployment levels, higher payroll taxes, and reductions in government assistance programs have created more pressure on these lower-income customers.

Tough times ahead
Family Dollar employed a strategy of offering discounts on certain items and made up for those discounts by raising the prices of other items. However, this strategy hasn't worked quite well since shoppers are looking for everyday low prices rather than discounts on select items. Moreover, Family Dollar also had to incur costs in printing circulars to promote the discounted items, apart from spending effort on rearranging stores to better highlight them. 

Clearly, Family Dollar's strategies have failed to attract shoppers on a budget, and the competition is eating its lunch. As such, the company now expects its same-store sales to decline in low-to-mid single digits in the upcoming quarters. Additionally, Family Dollar trimmed its guidance for fiscal 2014, lowering the earnings-per-share range to $3.25-$3.55 from the former $3.80 -$4.15. 

Now, Family Dollar is looking to arrest the decline by looking to lower overall prices. However, there is no instant relief in the cards since rivals are probably better positioned. According to a Kantar Retail Survey, Dollar General is the least expensive place to shop, with an average basket price of $28.70 --  7.4% cheaper than Family Dollar, which was third in the survey with an average basket price of $30.81.

Dollar General has a network of more than 11,000 stores, and it plans to increase its store base by another 27% in the future. So, a combination of low prices and an increasing network of stores can make life difficult for Family Dollar going forward.

Then there's Wal-Mart, which was just behind Dollar General in the Kantar survey with an average basket size of $28.82. Going forward, Wal-Mart can make things more difficult for Family Dollar as it expands its neighborhood market stores. Wal-Mart plans to increase the number of its smaller stores by around 75% in the next year or so, and it is also testing the Express format, its smallest store concept. Thus, like Dollar General, Wal-Mart is also a big threat for Family Dollar going forward with its low prices and wide network.

The takeaway
Family Dollar's strategies have failed to click in a difficult retail environment. Management expects same-store sales to go south in the future and has also reduced its earnings forecast for the fiscal year, which should be a good enough reason for investors to question holding Family Dollar shares.

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Fool contributor Harsh Chauhan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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