Dollar Tree (NASDAQ:DLTR) is known for its no-nonsense, everything-for-$1 pricing model. The company has been able to maintain it since it was founded in 1986, but given inflation and other pressures, some investors have called into question the long-term viability of this strategy.

Embracing a willingness to test new ideas, the company announced it would experiment with multi-tier pricing at a limited number of test stores. This is a major change to the business model that could have big implications for the company's brand and financial future if adopted across the chain.

A jar with U.S. hundred dollar bills stuffed inside

Image source: Getty Images.

Dollar Tree's pricing model

Dollar Tree operates two retail brands, Dollar Tree and Family Dollar. The former is a discount variety store selling everything at a $1 or less; the latter, like Dollar General, is more of a discount grocery store and already sells items at various price points.

How has Dollar Tree kept up this strategy for the past 30 years? The company has primarily maintained its low prices by keeping its product sourcing costs low and delivering true value to its customers. Efficiently operating its global supply chain and network of over 7,100 stores has been the company's core competency and a key driver of its success.

The company has a few other tricks up its sleeve as well. At times, Dollar Tree has been able to acquire inventory from other retailers at a heavy discount and pass the savings along to customers. For example, movie theaters will sell Dollar Tree discounted candy with packaging depicting films no longer in theaters.

When Dollar Tree wants to "raise prices," it shrinks the size of the packages it sells. If the retailer sold a package of 12 pencils last year, it may sell a similar package with 10 pencils this year to pocket a higher margin.

Because Dollar Tree is opportunistic in how it sources goods, new items constantly show up in its stores. Customers enjoy the variety as well as the bargain pricing.

Pressures to change

More recently, however, Dollar Tree is under pressure from some of its shareholders -- mostly as a result of its 2015 acquisition of Family Dollar, which has failed to live up to expectations. In January 2019, activist hedge fund Starboard Value took a 1.7% stake in the company and called for it to sell its Family Dollar business and consider adopting a multi-price point model at its Dollar Tree stores.

Starboard fears that the $1-for-everything strategy sacrifices quality for price, meaning consumers will no longer see value in what the retailer offers. The hedge fund noted that selling some items at $1.50 or $2.00 would still be true to the company's brand image, not to mention the possibility of introducing new products and better quality. Finally, Starboard noted that competitors such as Dollar General have had great success with a more flexible pricing strategy.

Dollar Tree Plus!

As it turns out, when Dollar Tree announced first quarter 2019 earnings, it not only surprised investors with good results, but managment also detailed a plan to experiment with new pricing at some Dollar Tree brand stores.

In May, the company started selling higher-priced items under the Dollar Tree Plus! brand in more than 100 locations. The vast majority of items will still be $1, but differentiated product sizes and value will come with slightly larger price tags. The company noted that it will pay close attention to how customers respond to the experiment in addition to its direct financial impact.

Changing the pricing strategy comes with risks. For one, there could be some pushback from customers as is often the case with higher prices. Another risk is that the Dollar Tree brand will no longer stand out as a retail concept versus other discount chains. 

Looking ahead

It's great to see Dollar Tree embrace the potential for change and test new ideas -- even if some customers find them contrary to the company's perceived ethos. New pricing opens up potential avenues for Dollar Tree stores to offer a wider range of merchandise without abandoning its value-focused appeal.

If the strategy works, Dollar Tree should proceed carefully. It needs to offer customers compelling deals while keeping its retail concept and inventory mix sufficiently differentiated to keep customers coming back again and again.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.