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The Bargain-Basement Economics of Dollar Stores

They sell versions of things you’ve never heard of for very little money. But how can they afford to exist?

Dollar stores — they’re everywhere these days. Why? Because this is America, dammit, and we want to stock up on party supplies, instant mac ’n’ cheese, a dustpan, dog food and the cheapest batteries you’ve ever seen, all in one place, for the amount of money you can find under your sofa cushions. 

But how can dollar stores stay open in a world where even department store giants like Barneys can’t afford to keep the lights on anymore? What’s with their weird inventory? Should you ever buy food there? Alongside true dollar store industry expert John Strong, CSX professor of Business Administration and Economics & Finance Area Head at William & Mary’s Raymond A. Mason School of Business, we’re going to find ourselves some bargain answers.

Dollar stores seem like they’re everywhere, but how many are there really?

Even more than you probably think. According to Strong, the three biggest stores — Dollar Tree, Family Dollar and Dollar General — have about 31,000 stores altogether in the U.S., and that’s not even counting the many other, smaller fish in the dollar-store industry. For comparison, CVS, Walgreens and Rite Aid combined have about 20,000 stores. 

Do they make any actual money?

Er, yeah. In terms of annual revenue, those three major dollar stores are at about $50 billion. Target brings in $80 billion (“Walmart is in its own universe at around $520 billion,” Strong says). 

How can they make $50 billion selling everything for a buck?

There are a few reasons. “One is that while the prices are low, their costs are really low,” Strong says. Think about gross margins: The sale price minus the cost of the goods. Walmart’s gross margin is 25 percent, meaning that a $10 item for sale at Walmart cost the company $7.50. Dollar stores’ gross margins are even higher at 30 percent (Dollar General) and 36 percent (Dollar Tree). Obviously they’re selling some pretty cheap items: Those party favors selling for a buck might’ve cost the company 20 cents, for example.

Now think about operating costs. Most dollar stores are basically self-service, and most employees make minimum wage. Then there’s the rent: You won’t find dollar stores on Rodeo Drive; they tend to reside in locations slightly off the beaten path. It’s all part of the strategy: The founder of Dollar Tree was famous for saying, “We go where they ain’t,” meaning markets too small for Walmart, supermarkets, drugstores or anyone else. 

“If you’re Walmart, these markets are too small for the format you want to build, and if you’re Amazon, these aren’t customers that live in neighborhoods that are digital-friendly,” Strong says. “And so, it’s a market segment that’s kind of in between. There’s no big guy that looks at that and says, ‘Boy, that’s a huge opportunity for us.’”

So the target customer is basically poor?

That’s one of its target markets, yeah. The original models were that Dollar General went into small towns and rural America, while Family Dollar went into the poorer suburbs of cities as well as second- and third-tier cities. But then the recession happened, during which, for obvious reasons, dollar stores were one of the few retail formats that kept opening lots of new stores. The new stores were somewhat nicer (featuring coolers and freezers for more food items), and soon middle-class customers on a recession-era budget also discovered the janky charms of dollar stores en masse. 

Are they really cheaper than Walmart?

We all know you can find some incredibly cheap things at a dollar store, but generally speaking? No. Think of it like Ace Hardware compared to Home Depot, or 7-Eleven compared to a supermarket. You can buy a pack of 20 paper towels at Walmart, whereas you can get a two-pack at a dollar store, and the unit cost of each roll at the dollar store is going to be more expensive. 

They’re using the dollar store format to rip people off, then?

Well, that’s hard to say. Dollar stores have gotten so big now that they’ve largely abandoned the old notion of going to China, buying a bunch of cheap merchandise and throwing it into a shipping container that says AMERICA OR BURST. They’ve now built their own supply chains and distribution centers, have big buying power and nowadays will approach, say, Nabisco, and tell them, “make me a package of Ritz crackers I can sell for a dollar.”

But while it’s nice to have better quality items available, there are still those janky elements in play. A dollar might seem like a bargain for a roll of aluminum foil, but later you may discover that while the roll is packaged like a 50-foot box of foil, the dollar store version might have only 10 feet of foil within. It’s a huge thing that Strong says to be aware of when dollar store shopping.

So they’re basically preying on poor people.

That’s a complicated topic. Strong explains, “If you think that the comparison should be Walmart, Costco or Aldi or someone like that, then the dollar stores are certainly higher price and less value — but relative to what’s actually in those local markets, I think they offer convenience. Because in a lot of those areas, it’s an hour on public transit just to get to the closest Walmart. So in those settings, it represents the best value in the market.” 

The other point he makes is that a lot of these customers are severely budget-constrained, and it’s pointless to say that 20 paper towels at Walmart is a better value for someone can’t actually afford to buy 20 — they can only afford two. “So it doesn’t matter if you can buy 20 rolls for $10 if you only have $2,” he says.

The median household income in the U.S., Strong says, is a little bit under $60,000. Dollar stores are basically designed for households between $20,000 and $50,000. “And there’s a lot of those people, all over the country,” he explains. “So I think what you have to give [dollar stores] a lot of credit for is that there’s a market out there, and it tended to be underserved. There’s lots of critiques, but on the other hand, nobody else went into that space.”

What’s with all the weird brands I’ve never heard of that I see in dollar stores?

Dollar stores usually carry the sub-brand of a sub-brand, or even some random private-label product — that’s how they keep costs low. “The model underneath it all is, ‘Keep it good enough,’” Strong says. So while you might not find Kraft mac ’n’ cheese, rest assured you can find Loretta mac ’n’ cheese.

I have to know: Do those batteries at the dollar store actually work?

When it comes to private-label batteries and electronics, Strong says they’re “as cheaply made as you could possibly get, so yeah [avoid them].”

What about cosmetics? Is the sunscreen on the shelf about to expire?

“These tend to be like buying any private-label, unknown brand in the category,” Strong says, like grocery store-brand razor blades. What are you really expecting out of them? “The way I’d think about it is, it’s cheap — and cheap usually comes with shorter expiration dates and whatever else.” 

How’s the food?

You may come across some Chef Boyardee that was destined for a supermarket before the order was cancelled, but generally it’s a lot of private-label canned and frozen foods, and milk that’s actually very well-priced. Fresh food is a rarity — Strong compares it to what you’d find at a 7-Eleven, e.g., mediocre apples and bananas. But again, to compare it to supermarket-level quality is to slightly miss the point. In many areas, it can be preferable to the decrepit mom-and-pop grocery stores or the run-down bodegas nearby.

What should I buy at dollar stores, then?

The internet is full of lists of what to buy at dollar stores, but Strong says many disposable things are a good buy: paper plates or party favors, for example (the successful Party City chain is basically a riff on the dollar-store concept, Strong points out). Home goods are also a great buy at dollar stores — say you need a broom, as long as it doesn’t have to be a great broom. Or a dustpan. These “good-enough” items are right in the dollar-store wheelhouse. Cheap decorative items like picture frames are good buys, too. Also: seasonal stuff like Halloween or Christmas decorations. All of this is prime dollar-store territory.

All in all, dollar stores are successful because they fill a need and have some great buys within. Just be sure to know what you’re getting into, both when it comes to the per-unit price of items, and the quality. “Cheap doesn’t always equal good value,” Strong says. However, the chance to buy flimsy toys, toilet paper, a random flower vase, toothpaste and a Halloween costume all for a few bucks? That’s always gonna be a unique dollar-store experience.