Petco Animal Supplies, Inc. Business Information, Profile, and History

Company Perspectives:

Petco's Strategy is to become the leading category-dominant national chain of community pet food and supply superstores by offering its customers a complete assortment of pet-related products at competitive prices, with superior levels of customer service at convenient locations.

History of Petco Animal Supplies, Inc.

The second largest pet food and supplies retailer, Petco Animal Supplies, Inc. operates a chain of superstores that sell a broad selection of pet merchandise. By the end of the 1990s, Petco operated 482 stores in 37 states and the District of Columbia. Trailing PETsMART--the only other publicly held, national pet merchandise chain--Petco positioned itself as a premium retailer, deriving the bulk of its sales from premium pet brands such as IAMS and Science Diet. The company's stores averaged 15,000 square feet and stocked roughly 10,000 items. An aggressive acquisition campaign during the middle and late 1990s led to financial problems for the chain, but by the end of the 1990s it was showing signs of recovery.

Birth of the Petco Superstore

Petco had been operating as a retailer of pet food and supplies for nearly 30 years before the company launched its bid to become the dominant national player in its industry. Founded in 1965, the company competed during its first decades as one of the hundreds of regional pet merchandisers scattered across the country who found it difficult to operate under the shadow of the all-powerful supermarkets. In the battle to lure pet owners into their stores, the supermarkets prevailed comfortably, accounting for 95 percent of all the pet food sold in the country. Their dominance came at the expense of specialized retailers like Petco, but beginning in the mid-1980s the stifling grip maintained by the supermarkets started to weaken. The cause for the change was part of a pervasive transformation of the retail industry as whole, a trend that saw massive "warehouse" discount stores and "superstores" secure a substantial foothold in the retail sector. Along with the growing prominence of these new retail formats, the diversity of pet products--particularly food--increased, providing a lucrative niche for the specialized retailers to exploit. Supermarkets had held sway by stocking their shelves with popular brands such as Alpo, Kal Kan, and Purina, but beginning in the mid-1980s new premium brands of pet food were introduced into the market. Premium brands such as IAMS, Science Diet, and Nutro that offered higher levels of nutrition than the supermarket brands became increasingly popular among pet owners, and specialized pet products stores were the only retailers to carry such brands. The changing dynamics of the pet products industry led to the decreasing strength of the supermarkets and the growing prominence of retailers like Petco. Between the mid-1980s and the mid-1990s, the percentage of pet food sold in supermarkets slipped from 95 percent to 50 percent, with specialized pet products retailers, warehouse clubs, and mass merchandisers accounting for the change. The conditions were prime for Petco's growth and expansion into a national chain. In the reshaping of the pet products industry, the nearly 30-year-old regional retailer played a leading role.

Petco did not begin to transform into a national force until after its 1994 initial public offering (IPO) of stock, but the individual who spearheaded the mid-1990s expansion arrived as the decade began. Brian K. Devine joined Petco in August 1990, bringing with him 20 years of retail experience. Prior to his arrival at Petco, Devine had served as president for Krause's Sofa Factory, a furniture retailer and manufacturer, but the bulk of his professional experience came from his association with Toys 'R' Us, a retailer of children's toys. From 1970 to 1988 Devine served in various capacities for the specialty retailer, including as senior vice-president in charge of growth, development, and operations and as the chain's director of stores. His background in specialty retailing contributed to the personality of Petco as a national retailer, distinguishing it from its main rival, but the company did not take on this personality until it fully embraced the superstore concept. The transition from operating traditional stores to superstores had begun by the early 1990s, when there were nearly 200 Petco stores of various sizes in operation. The majority of the stores consisted of Petco's traditional units, which measured roughly 3,500 square feet. The company had discovered, however, that it could achieve greater customer traffic, sales volume, and profitability with a larger format: Petco's prototype superstore. Petco's superstores were five times larger than the company's traditional units, stocking a full range of pet food and supplies, as well as fish aquarium systems, reptiles, and other small animals--selections generally not available at the traditional stores. By the end of 1991, the company had established 37 superstores, recording sufficient success with the new format to convince executives to direct expansion efforts toward the establishment of additional superstores. Although Petco officials had not abandoned the traditional concept and would continue to operate smaller units that were profitable, the first half of the 1990s would see an increasing number of Petco superstores and a decline in the number of traditional stores.

By the end of 1992, there were 208 Petco stores in operation, 76 of which were superstores. The following year, the number of superstores exceeded the number of traditional stores for the first time, with the 239-unit chain comprising 132 superstores and 107 traditional stores. By this point, the success of the superstore concept encouraged the company to expand more rapidly and give the superstore concept a national reach. To expand at a greater rate and to take advantage of market conditions primed for a company with Petco's characteristics, Devine, who was named chairman of the corporation in January 1994, decided to take the company public. Petco's IPO was completed in March 1994, giving the company the financial resources to step up its expansion, something Devine intended to do through acquisitions of smaller pet merchandise chains.

Mid-1990s Expansion

Over the course of the ensuing year-and-a-half, Petco completed 12 acquisitions representing 100 stores located in 16 states, converting the purchased units to its superstore format. Petco's superstores carried a merchandise assortment of more than 10,000 items, which was far more than the 400 items generally stocked by supermarkets. Inside the stores, the shelves were stocked with premium cat and dog food, grooming products, toys, and a broad assortment of pet-related items whose diversity was intended to stimulate impulse purchases. Confronted with crab-and-tuna-flavored cat treats, peanut butter-flavored dog biscuits, orthopedic dog beds, bird beak conditioners, pet greeting cards, and numerous other pet-related items, customers responded by generally buying more than they originally intended. It was a marketing strategy one Petco employee summarized by saying, "They'll come in to just buy dog food and end up buying toys and treats." Petco customers admitted as much, their buying habits typified by one customer who explained, "I usually pick up something that I didn't intend to buy. I even look at the dog stuff and I don't have a dog."

Aside from tantalizing its customers with a vast array of pet products, Petco devoted considerable effort to ways in which products were presented to customers. One of the signature traits of the chain was its practice of incorporating the merchandising ideas of other retailers, including competitors big and small and retailers outside the pet products industry. The company's senior vice-president of merchandising and distribution traveled worldwide searching for innovative ideas from his visits to other stores. For example, the idea for a brochure stand that began appearing in Petco superstores was first seen by a Petco executive in a hardware store in Europe. The inspiration for a pet bar stocked with pet treats similar to a salad bar for humans was taken from a chain of pet stores in Boston. The result was the adoption of market-proven merchandising techniques and the elimination through assimilation of merchandising advantages held by competitors.

The rewards for capturing the spending dollars of pet owners were vast, estimated at $20 billion by the mid-1990s. Vying for a share of the annual, pet owner expenditures were legions of small, independent pet shops, supermarkets, mass merchandisers, and convenience stores. Petco perceived itself to be competition with all such pet products retailers, but the most obvious rival was the only other publicly held, national pet merchandise chain, Phoenix-based PETsMART Inc. Industry pundits preferred to view the two sprawling chains as waging a battle against one another for national supremacy, but Petco officials emphasized the distinctions separating the two companies and downplayed the drama of two industry heavyweights competing head to head. "There's a giant difference," Devine explained. "They're [PETsMART] catering more toward the grocery store user and the mass-market customer. We're catering more to the specialty retail customer. We both sort of picked our niches." The niches occupied by the two companies were reflective of the different professional backgrounds of the leaders who controlled each company. Devine's years at Toys 'R' Us influenced his decision to position Petco as a specialty retailer, whereas PETsMART's president and chief executive officer, Mark Hansen, used his experience as a grocery store veteran to pattern PETsMART after the supermarket model of high turnover and lower profitability. Accordingly, PETsMART focused on stocking less expensive merchandise in larger, 26,000-square-foot stores. Petco, on the other hand, based its strategy on retailing more expensive merchandise in smaller, 15,000-square-foot stores.

The contrasting philosophies of PETsMART and Petco also affected each company's real estate strategy, which was part of the reason Devine did not perceive the success of Petco as being dependent on the demise of PETsMART. Generally, the two chains were not side-by-side competitors; instead, each moved into distinct areas, pursuing different demographics. Typically, PETsMART located its superstores in what were referred to as "power centers" alongside other superstores and warehouse stores like Home Depot, Costco, and Staples, hoping to draw customers from outside their immediate neighborhoods. Petco, in contrast, established its stores within neighborhoods, positioning its premium outlets in local shopping centers anchored by supermarkets, where the company's target customer&mdashcounting for 70 percent of its customer base--frequented. "The educated woman is our best customer," explained Devine. "She's the best premium food customer. We try to place our stores where they shop on a regular basis. We try to go with the upscale grocer if possible."

Difficulties in the Late 1990s

With Petco and PETsMART occupying separate turfs and together controlling only five percent of a $20 billion market, there was substantial room for expansion as the two companies faced the late 1990s. Devine foresaw the expansion of Petco to 1,250 stores, roughly four times the size of the chain by the end of 1996, but as the company pursued its ambitious goal it faltered, sparking criticism that it had been over-zealous in its growth plans. Problems surfaced after the company registered an aggressive year of expansion in 1997, when 104 stores were added to the chain, with the majority of the new units coming from the acquisition of the 81-store PetCare chain, which operated in nine midwestern and southern states. The process of efficiently incorporating the new stores into the company's fold and continuing to transform from a 3,000-square-foot format to a superstore format proved to be difficult. As a result of the acquisitions that increased the company's store count to more than 430 units and extended its presence into 31 states, crippling financial losses were incurred. During the first half of 1998, Petco racked up more than $8 million in net losses. The company's stock, which had swelled to more than $30 per share in 1997, plunged to nearly $5 per share. One stock analyst offered his opinion, explaining, "The company has had problems because, frankly, they expanded their business too much, too fast. The company's costs got a little out of line of what they should have been." To make matters worse, the company also faced three class action shareholder lawsuits charging management with securities violations and fraud. The acquisition of nearly 20 retail chains since the 1994 IPO caused considerable strain on the once vibrant chain, but the late 1990s witnessed the recovery of the company that touted itself as the "premier specialty retailer of pet food and supplies in the United States."

By the early months of 1999, Petco began to display signs of vitality. The company had eased back on its acquisition campaign and focused on invigorating the profitability of its existing stores. The stores acquired in 1997 that had precipitated the company's downfall were expected to begin producing as well as the other units by the end of 1999. Analysts, who previously had warily distanced themselves from the company, began to view Petco's prospects more positively. The cause for their more sanguine outlook derived from the company's emphasis on producing returns to shareholders and its new growth strategy. Petco operated 476 stores in 37 states and planned to add to its store count, but expansion in the years ahead was expected to come from the construction of new stores rather than through acquisitions, thereby avoiding the pitfalls of converting stores to the Petco format. In 1999 the company planned to build 40 new stores. As Petco pushed ahead with its plans, its future success depended on producing consistent earnings growth, something that eluded the company during the 1990s. A perennially growing market and a tighter control on profitability, however, engendered optimism for the 21st century.

Principal Subsidiaries: International Pet Supplies and Distribution, Inc.; Pet Nosh Consolidated Co., Inc.; Petco Southwest, Inc.; Pet Concepts International; PM Management Incorporated; Petco Southwest, L.P.