2005 State of the Industry

December 1, 2005 By    

Slightly more than 35 percent of the participants in this year’s State of the Industry survey offered comments beyond the questions asked. It would be an understatement to say the comments implied that the situation was nearly untenable, and that no improvement was in sight.

However, when asked for this year’s results and future predictions for specific characteristics of their businesses, respondents painted a surprisingly brighter picture.

Increased product and delivery costs as well as energy conservation efforts by consumers are among the concerns of propane retailers in this year's State of the Industry Report.
Increased product and delivery costs as well as energy conservation efforts by consumers are among the concerns of propane retailers in this year’s State of the Industry Report.

The state of the industry’s business is actually somewhere in the middle. It’s an industry that is coping with enormous hurdles, while, at the same time, it is enjoying some success and a bit of growth.

Coping

There is an interesting change in the tenor of the comments received this year. In the three years after 2001, the comments were often those of rage – railing about one hardship or another.

All of the demands of security and safety regulations, the cost of insurance or even the difficulty of getting it, the cost of employee benefits and the difficulty of finding drivers who can qualify for certification are still there, and, in most cases, loom larger. They simply seem now to have become facts of life. They are no longer new. They still create enormous difficulties. But the feeling overall has changed from rage to coping. Companies are trudging on, being as successful as possible in this redefined business climate.

Survey respondents continue to express concerns about product price volatility and unpredictable supply.
Survey respondents continue to express concerns about product price volatility and unpredictable supply.

In general, one can infer from basic elements of this year’s survey that propane retailing has changed very little since last year’s survey report. With few exceptions, businesses are structured very much as they were, with the number of facilities, amount of storage, number of bobtails and service vehicles, number of customers in each category of propane usage, other propane-related products and services offered and allocation of promotion and advertising dollars all staying much the same.

The one predominant issue that has understandably emerged this year is price – the price of propane as well as the price of other forms of petroleum-based energy. The effects of this are evident in many areas of the propane retailing business, with two-thirds of comments from respondents regarding price.

Although the cost of motor fuel wasn’t asked about in the survey, respondents made clear in their comments that the price of diesel fuel has made a major impact on the cost of propane delivery. This introduces some interesting corollaries – the percentage of bobtails powered by diesel versus propane, and what seems to be a new interest in computerized fleet-management and routing software.

Use of Technology
Use of Technology

Another visible effect is the lessening of demand for energy. Some retailers are seeing a reduction in demand for propane due to conservation by their customers, which they expect to be a continuing trend as long as customers experience record costs.

There are other clues to customer issues.

Retailers are beginning to experience more problems collecting on their accounts receivable, as well as receiving more phone calls from price shoppers.

One of the most frequently mentioned challenges sited by propane retailers is finding qualified employees.
One of the most frequently mentioned challenges sited by propane retailers is finding qualified employees.

The more fundamental issue is the competitive position of propane in the energy market versus natural gas, heating oil and electricity.

Retailers are concerned not only about the levels of prices, but also the rate of price increases in relation to other energy sources. They are concerned about losing a long-standing advantage as the price of propane increases faster than other energy sources.

There is also a reiteration of what survey respondents have said in past years’ surveys about the volatility and unpredictable nature of the price and supply of propane.

Other Products & Services
Other Products & Services

Competitive energy suppliers are making hay during this challenging time. Every year there are complaints about what some propane retailers consider the unfair tax advantages enjoyed by Rural Electric Cooperatives. This year they mentioned specific competitive strategies of electric suppliers, like pricing kilowatt hours at 3 cents or offering up to $1,000 in incentives for conversions to totally electric homes.

While not a new issue, there seems to be a stronger concern this year over cut-throat price-choppers, retailers new to the business that lure customers away with lower prices. A strategy that can be appealing to customers in these times.

Retailers are employing several tactics in response.

Sell Other Energy Products
Sell Other Energy Products

The first is trying to more aggressively manage expenses in relation to the prices they charge in an attempt to be more price competitive. That is very difficult in an industry where there are so few leverage points and so few things in the business over which a retailer actually has control. There are some options retailers are pursuing that may help, although the end result, unfortunately, is often merely eroding margins.

Another tactic involves inventive pricing and billing practices that include trying to tie in customers to long-term relationships with discounts for extended contracts, in addition to more typical discounts related to volume and cost of delivery. However, while advantageously keeping customers, the discounts oppositely yield an overall lower margin.

Some retailers hope to wait them out, believing that bargain basement tactics of price-choppers won’t keep these competitors in business for long. However, despite their eventual demise, price-choppers can leave customers expecting those bargain prices to be the norm.

Employee Benefits in 2005
Employee Benefits in 2005

This year survey responses noted that more retailers have adopted a somewhat philosophical point of view – that the propane business must be a legitimate operation, characterized by adherence to regulations, insurance requirements, safety considerations and good customer service. They further believe that those who provide these services deserve adequate margins. They are going to continue operating in this manner and let the chips fall where they may.

Leverage Points

One way of improving effectiveness and efficiency of operations that is increasingly being used is technology. Historically, the propane retailing business has been slow to include technology in their operations. Over the last few years, however, more retailers report that they are using computer systems, primarily for their administrative and record-keeping functions.

The chart at right shows that 63.9 percent of retailers responding to the survey now have computerized accounting systems. Traditionally, the next move in any industry is to include technological systems in their mainline business, and that’s beginning to happen in propane retailing. Of the respondents, 6.8 percent report using in-truck computer systems, 23.3 percent fleet routing software.

Intensity of Competition
Intensity of Competition

That trend appears to be increasing, with 27.1 percent planning to add more technology in the coming year. Interestingly, just 11.1 percent are catching up by adding computerized accounting systems. An increasing number are planning to add systems that help them with the mainline activities of selling and delivering propane to customers.

Forty years ago, the financial and investment community developed a theory that described an age-old maxim: “Don’t put all your eggs in one basket.” The Portfolio Theory said that any good investment strategy included a diversified collection of investments in various, non-similar stocks. The purpose was to ensure that if one industry were down, another would be up, and the investor wouldn’t be subject to wild swings.

The same concept applies in the propane industry, wherein some retailers are pursuing that diversification strategy. Their first step to diversify is selling propane-related products and services. Obviously, these still are dependent on a level of propane use. The first chart shows the percent of retailers who augment propane sales with products and services.

Retailer Promotion
Retailer Promotion

Within a statistical margin of error, this is nearly identical to the list included in the 2004 report.

The next step away from depending solely on propane sales is other energy sources. While they are competitive with propane, other energy sources satisfy the same or similar demands in the same or similar markets, and react to many of the same market drivers. The second chart shows the various fuels that 39.8 percent of propane retailers reported selling.

While retailers report sales of propane-related products and services account for only 7.5 percent of their total sales, they say that 24.3 percent of their sales come from non-propane-related products and services, including other energy sources and totally unrelated products. Given these statistics, it should be no surprise that 21.8 percent of propane retailing respondents don’t consider propane retailing to be their primary business.

Competitive Advantage
Competitive Advantage

Frankly, in lieu of asking that question on the survey, you probably wouldn’t have guessed that is the case. Interestingly, that pertains to nearly all size categories of retailers, regardless of number of gallons sold.

On the other hand, there is an increasing number of retailers who plan to increase their presence in the retailing business and enjoy larger economies of scale by acquiring other propane retailing businesses. This year, 17.3 percent of survey respondents – about one-third higher than 2004 – predicted they would acquire.

Business Practices

Employees. One element of the business that is frequently mentioned under the caption of “Challenge” is finding qualified employees.

Propane retailers report that urban sprawl continues to increase demand for propane nationwide.
Propane retailers report that urban sprawl continues to increase demand for propane nationwide.

The average retailer has 7.5 employees, 6.5 of those being full-time, the remainder being part-time or seasonal employees. Interestingly, retailers predict that number to drop slightly to 7.2 in 2006 – an indicator that is consistent across nearly all size categories of respondents.

The type and frequency of employee benefits show little change from 2004, shown in the chart to the right.

As seen consistently from year to year, larger retailers typically offer a higher level of benefits than smaller businesses, and investor-owned and co-op retailers offer benefits more consistently than owner/operators.

Propane-powered vehicles
Propane-powered vehicles

The cost of providing benefits continues to grow. This year respondents report an average 13.3 percent increase in benefit costs. The good news is that this is a smaller increase than was seen in previous years – that is, if a 13.3 percent increase on top of a compound increase of 44 percent over the 2003-2004 period can be considered good.

While the level of benefits seems to be reasonable, possibly even generous, at a time when companies in many other industries are negotiating lower levels of benefits, the $12.55 per hour average wage rate is at the low end of the spectrum. Retailers report this is a 5.9 percent increase from 2004.

Competition. Retailers face an average of seven competitors in their market areas, and this year saw an average of nearly one new competitor emerge in each area.

Availability of propane supply – and its related cost – remains a central issue for propane retailers.
Availability of propane supply – and its related cost – remains a central issue for propane retailers.

Although retailers were categorized differently in this year’s survey, the first chart demonstrates that the level of competition from each type of retailer remains about the same as it was in 2004. Of course, much of that is influenced by the mere presence or absence of a type of retailer in a market area.

Again this year, retailers claim a larger than proportional share of customers in their market area who buy propane exclusively from them. In the average market area with seven competitors, one could expect each retailer to get, on average, 14.3 percent of total customers. This year, retailers reported to have, on average, 39.7 percent of all propane users in their area buy exclusively from them.

As usual, “Lower prices” was not considered a prime competitive advantage – its associated margin problems seeming to preclude consistently lowering prices sufficiently to gain a real advantage. Instead, “Predictable prices” and “Flexible payment options” were rated higher in importance as elements of customer service than the actual level of prices.

Retailer' Business Expectations
Retailer’ Business Expectations

As you can see in the chart below, retailers consistently rate “Customer loyalty” and “Quality of service” as their most important competitive advantages. In this year’s survey, the “Quality of service” label was broken up into “Dependable monitoring & refilling” and “Quick response maintenance.”

It was no surprise that both were rated high – 66.9 percent and 65.4 percent respectively. But, interestingly, there was a very high correlation between those two characteristics and “Customer loyalty.” Rarely was one indicated independent of the other on the survey and most were with “Customer loyalty” as well.

That raises an interesting question that may offer an important lesson. What is customer loyalty? Is it merely a retailer having been the Gas Man for many years? Or does it mean that the retailer has been responding to customers’ needs quickly and dependably? If the service were no longer responsive and dependable, would the customer still be loyal? Perhaps this just reiterates that propane retailing is, after all is said and done, a service business.

Promotion. The ways propane retailers advertise and promote their businesses demonstrate that propane retailing is essentially a local business. The middle chart shows that the most-used media typically have the smallest market area. Yellow Pages and newspapers are used extensively, while television and magazines are rarely used by retailers.

Perhaps the question concerning advertising and promotion rests with answers to the competitive advantage question. With only 6.8 percent of respondents listing “Better advertising and promotion” as a competitive advantage, do retailers think they don’t do a very good job of advertising and promotion? Or do they believe that advertising and promotion can never be effective enough to provide a competitive advantage?

Propane supply. As with other aspects of the propane retailing business, how the supply of propane is physically acquired is somewhat a function of a retailer’s size. On average, 43.6 percent of retailers take delivery from the supplier. In addition to the location of the supply, this is often determined by the size of the retailer, with 69.0 percent of those selling less than 500,000 gallons per year getting supplier delivery. At the other end of the size spectrum, only 15.4 percent of larger retailers get supplier delivery.

Likewise, of the 56.4 percent of retailers who pick up their propane from pipeline, rail car or supplier storage, an average of 10.3 percent of the smallest retailers use their own trucks, while 26.9 percent of the larger retailers do so.

Customer Pricing and Billing. Understandably, there are benefits to having long-term contracts with customers. In addition to certainty of sales, long-term contracts can help with propane purchase projections and timing.

Of course, the other side of the coin is what must be offered to customers to entice them to enter into long-term contracts – especially in view of high, fluctuating prices and the nagging presence of cut-throat cost-cutters among competitors.

The most-used discount for long-term contracts is based on the volume of propane to which customers commit. Only 12 percent of retailers based their discount on the size of a customer’s storage, although -assuming sufficient delivery capacity – large storage would obviously require fewer deliveries and, consequently, reduce a retailer’s annual cost of delivery to a customer.

By far, the most-used method of invoicing was the traditional billing-after-delivery with standard terms for payment. Roughly a third (30.8 percent) of respondents reported billing in advance of delivery. Other methods accounted for 12 percent, including payment up front for the entire heating season.

Propane-powered vehicles. For an industry dependent on the use of propane, retailers are rarely committed to using their own product, they’re more inclined to use diesel-powered vehicles. The average respondent’s fleet includes 1.8 propane-powered vehicles, representing just 34.2 percent of the fleet.

When the survey asked retailers why propane-powered vehicles didn’t comprise more of their fleets, their answers varied.

Retailers are essentially saying that the infrastructure – manufacturers, dealers and service providers – is not sufficient to support widespread propane-powered fleets, even for propane retailers. Reliability, power and fuel efficiency were also at issue.

On the other hand…

There certainly is enough evidence to suggest that propane retailers are a pretty discouraged lot. However, there are patterns that question whether or not that should be the conclusion.

Many aspects of the propane retailing business have changed since 2001, and most of those changes have added burdens and increased the cost structure measurably. One retailer from last year’s survey summed up the situation by saying: “This was a good way to make a living, but with everything that’s happened, it has sort of taken away some of the fun.”

Altogether, propane retailers must be a hardy group, because, as they look to next year, they see their businesses, the size of their businesses and profits growing.

The chart on the following page details some of those indicators.

While there are no major changes, taken together, these retailer expectations are quite positive. Compared to last year’s survey, there are far fewer responses that demonstrate pessimism. The percentage of retailers who expect to have fewer customers in the coming year went down from 13.7 percent to 10.5 percent, and the percent who believe profits will decline in the coming year fell from 31.7 percent in last year’s survey to 15 percent this year.

Perhaps more indicative of the overall attitude is the percent of respondents who expected to be acquired fell from 13.3 percent last year to 5.3 percent this year (for all retailer size categories combined).

Among the smaller retailers – those selling less than 500,000 gallons per year and in many ways the ones most at risk from the collection of new challenges – those expecting or hoping to be acquired plummeted from 20.9 percent last year to 3.4 percent this year.

Hope springs eternal

The survey was surprising. Given what’s been heard from retailers responding to the surveys over the last few years, it was expected to find an industry sliding further down the slope, just trying to survive.

There is no question that some retailers are in that situation. But, as a whole, it appears the industry is moving through a process of integrating the challenges into business as usual and has reached the point of “Let’s just move on.”

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