Bigger is not necessarily better; the bankruptcy of giants like Lehman Brothers and General Motors should set warning bells ringing for empire-building CEOs. In contrast, companies like Hibbett Sports (NASDAQ:HIBB), Tractor Supply (NASDAQ:TSCO), Fairway Market (NASDAQ:FWM) have delivered financial performance superior to the giants of their industry by becoming strong market leaders in their respective market niches.
Growth is the enemy of competitive advantages, as it attracts new entrants and larger competitors. Hibbett, a sporting-goods retailer operating in the South, Southwest, Mid-Atlantic, and the Midwestern parts of the U.S., focuses on smaller niche markets ignored by its bigger peers; the population size of these markets is in the 25,000 to 75,000 range. In comparison, although its peer Dick's Sporting Goods also aims at smaller population centers with single-level stores, these stores are mostly located in regional shopping centers.
There are two key reasons why Hibbett's small market focus is a strong competitive advantage. Firstly, the small markets that Hibbett operates in are already well served, leaving little room for a second dominant player. Any new competitor has to bet the house on seizing market share from Hibbett instead of relying on organic market growth. Secondly, given the local nature of retail, Hibbett derives significant economies of scale in marketing, distribution, and rental expenses. This gives it a tremendous edge over new entrants, which have to start from ground zero in the new market at a significant cost disadvantage.
The results speak for themselves. For the past five years, Hibbett has seen its revenue grow by a compound annual growth rate of 9.5% and its operating margin expand from 8.5% in fiscal 2009 to 14.2% in fiscal 2013.
Tractor Supply, the largest operator of farm and ranch stores in the U.S., serves a niche customer segment comprised of recreational farmers, ranchers, and tradesmen. Unlike general-merchandise retailers, Tractor Supply customizes its products to cater to the unique needs of its niche customer base.
More than 40% of its revenue is generated from the sale of products related to livestock and pets. This isn't hardly surprising, considering that most of its customers are pet and animal owners, and Tractor Supply has this in mind when it comes to its merchandising strategy. Another validation of Tractor Supply's success in product customization lies in the penetration rate of its private-label products. It increased its proportion of in-house brand sales from 21% in fiscal 2010 to 25% in fiscal 2012. Going forward, Tractor Supply also plans to expand its offerings of 4health, its pet food private label, and its C.E. Schmidt brand of work wear.
Similar to Hibbett, Tractor Supply has achieved strong top-line growth and margin expansion in recent years. For the past five years, its operating margin has more than doubled from 4.5% in 2008 to 9.4% in 2012. During the same period, its revenue grew by a CAGR of 11.5%.
Niche markets needn't be confined to small rural communities; upscale New York is perfectly fine as well. Fairway is a leading food retailer with 14 stores in the greater New York metropolitan area. Despite its smaller store footprint, it boasts of the highest store productivity in the industry. Fairway makes an average of $1.2 million every week from a single store; in comparison, its peer Whole Foods Market generates about $700,000 in weekly sales per store.
The small number of stores and its narrow geographical focus are key factors for its industry-leading operating metrics. One of the reasons for the weakening of bigger companies is the dilution of managerial attention. As companies grow bigger, there are more layers of management hierarchy and less attention is paid to any individual store. Top executives have to fly to visit distant stores, and group- level managerial meetings are held infrequently for the same reason. In contrast, the clustering of stores in New York means that Fairway's top management spent more time in stores than travelling between them.
Furthermore, Fairway boasts of about 70,000 SKUs, or stock-keeping units, in its stores on average; this is significantly higher than its peers Whole Foods Market and The Fresh Market, which carry approximately 21,000 and 9,500 SKUs, respectively. Therefore, the greater level of management attention afforded by Fairway has enabled it to pick the right items favored by its customers and avoid SKU proliferation at the expense of profitability.
Foolish final thoughts
Successful niche retailers can be significantly more profitable than their larger competitors, as they benefit from the lack of competition, a higher level of product customization, and greater managerial attention.
Mark Lin 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.