State of the Industry 2002

In some ways, today’s retail propane market is identical to the industry that has sustained American family businesses for more than four generations. But change is arriving on many fronts, according to the propane marketers who shared insights of their business for our third annual State of the Industry Report.

The results of this survey offer a number of insights into the propane retail industry. Some of the findings confirm intuitive suspicions. Others defy the conventional wisdom. And yet others highlight interesting questions with often seemingly conflicting answers.

Technology is moving into our industry. A growing number of retailers – both large and small – have reduced the number of employees with the use of computers.

The face of your competition is changing. A high percentage report new competition moving into their market areas, including competition from other energy sources. More than half of our survey respondents said they had lost customers to other energy providers.

The trend of acquisition and consolidation in the industry is accelerating. Of the largest retailers, 51.6 percent plan to acquire other companies next year, compared to the 9.7 percent who made acquisitions in 2002. And one-fourth of the retailers who sell less than 1 million gallons per year say they expect to be acquired in the next 12 months.

Cold weather and a healthy national economy still rank high on the list of concerns for retailers. But they’ve been passed by soaring insurance costs and related safety issues, more regulatory and compliance obligations and the looming security issues related to national terrorism.

Our survey’s objective was to gather information with sufficient validity to make reasonably accurate inferences and conclusions about the entire population of U.S. propane retailers. Survey forms were sent to 2,000 retailers; 311 (15.6%) responded. From the total, we retained 258 surveys in the database, representing those that were timely and complete enough to be useful and consistent enough to demonstrate honest, knowledgeable answers that fairly represented the industry’s characteristics.

We believe the results fairly represent the entire retailer population in most respects, including size, geographic location and operational characteristics.

We hope this report helps you better understand the trends and unique challenges of the new century.

Age

As reported in the 2001 survey, the propane retail industry is very mature. The “new” businesses – those with sales of less than half a million gallons – have existed an average of 20 years. Interestingly, there is a strong correlation between size of business and years in business. Years in business climbs steadily with gallons sold, reaching the oldest average businesses – 42.4 years – in those selling over 8 million gallons per year.

Locations and Storage Capacity

As expected, all physical plant and equipment assets grow with number of gallons sold. While even the smallest group of retailers boast an average of 1.3 locations and more than one storage facility, they are dwarfed by the largest dealers with 11.9 average geographical locations and a whopping 765,845 gallons of storage (see chart 1).

Vehicles

This “rolling inventory” category creates a few questions and surprises. Until one examines the very largest group by gallons sold, the retailers appear to have more “other” vehicles than bobtails or bulk trucks. Even the large retailers have a significant number in the “other” category. What do they comprise (see chart 2)?

While this average is significantly impacted by the large retailers, the respondents as a whole have more propane-fueled vehicles than diesel by a 45.3 percent to 34.9 percent margin. Fewer than one in five vehicles is gasoline powered.

Other Products and Services

In general, as the size of the retailers increases they offer more ancillary products and services. It is interesting to note the number of retailers offering equipment service in relation to their answer to a later question concerning competitive advantage. There appears to be a correlation between those who believe their competitive advantage is customer service and those who offer equipment service.

In the midst of industry dispute and confusion regarding the future of propane-fueled vehicles, only 4.7 percent of the respondents offer vehicle conversion services.

Advertising

We were a bit surprised by the number of retailers who advertise. The newspaper media led the way with 67.1 percent, while only 2.7 percent of the retailers were seen on television.

The industry is getting on the Web. On average, 25.6 percent indicated they advertise on their Web site, with even 7.9 percent of the smallest participating on-line, and nearly 50 percent of the large retailers.

Employees

Not surprisingly, the respondents displayed few plans to significantly increase their workforce.

Another sign that technology is moving into this mature industry is the number of retailers who say they have eliminated or minimized the increase in number of employees with the use of computers. As one would expect, the largest retailers have the most opportunity to take advantage of information systems in lieu of employees – 48.4 percent. But even in the smallest category of retailers, 22.6 percent have used technology to minimize direct labor costs.

Customers

Similar to the results reported for the workforce, retailers expect to gain few customers in 2002. Retailers still serve a primarily residential clientele, and appear to be adding more “keep full” customers (see charts 3A & 3B).

Customer-Owned Tanks and Filling Categories

While the responses to both of these categories appear consistent, both display a wide range of answers with large average deviations.

Sales and Prices

The percentage of propane sales by usage category and prices paid and charged were very consistent across groups, as was the percent of their business that came during the heating season. Although some surveys suggested there had been a significant regional price spike during the year, it appears that the average prices charged may have been less than last year. While average gallons sold in-creased by 9.3 percent, average revenue grew only by 6.3 percent.

It was certainly no surprise that the overwhelming majority of responses indicated that the weather wasn’t a friend to propane retailing in the 2001-02 heating season. Only 3.5 percent indicated that demand had increased due to weather (see charts 4A & 4B).

 

Competition

The responses bear out the natural conclusions: larger retailer, larger market area, more competitors. The smallest retailers face 7.5 competitors on average, while the largest compete with 20.7. One piece of information that is not available is the density of competitors per geographical market area. One would suspect that would be much more consistent across the market when comparing equal market-sized area, regardless of overall organizational size (see chart 5A).

One remarkable result regarding competition is that all groups – from mom-and-pop to the mega-retailers – claim an exclusive market share that is an essentially identical one-third of the customers in their market areas.

However, more than 40 percent of respondents see new competition moving into their market areas. About one- third of the smallest retailers expect new competitors, while nearly two-thirds of the largest retailers see similar challenges ahead. Again, this may be due in part to the larger market areas populated by large retailers with, therefore, more opportunity for new competitors.

With so much past acquisition and consolidation in the industry, one would expect that retailers would see the large, multi-state retailers as posing the most worrisome competition. In fact, the survey suggested that just the opposite is true. On a scale of 0 – 5 (with 5 indicating the stiffest competition faced) “local” retail competitors – with an average response of 3.33 – still commanded the most concern. This was followed by 2.57 for regional retailers, and 2.2 for multi-state retailers (see chart 5B).

Competition from other energy sources displayed an indicative contrast. While 52.7 percent said they had lost customers to other energy, their average number of customers lost was just 2.4 percent. However, given that this is nearly a stagnant market, one would expect that even 2.4 percent would be of concern. So it was surprising to find that 50 percent expect other energy sources to have a “minimal” effect on their businesses, and only 8.5 percent see the threat as “significant.”

Given the choice between “pricing,” “quality of service” and “customer loyalty” as ways to achieve competitive advantage, surprisingly, “pricing” was a distant third with just 31 percent responses. At 78.7 percent, “quality of service” was the clear belief.

This belief also grew measurably stronger as the size of the retailer grew. The smallest retailers, still not selecting price, chose quality 63.2 percent of the time, attributing a larger impact from customer loyalty. At the mega-retailer end, 93.5 percent of responses chose quality of service. Again, this may have some impact either on or from the percentage of retailers who offer equipment service.

The Future

When looking to the future, it almost seems that the respondents are indulging in a healthy dose of wishful thinking (see chart 6A).

During 2001, 5.4 percent of the respondents made an acquisition, including 16.1 percent of the largest retailers. This fell to 2.3 percent and 9.7 percent respectively in 2002. From 2001 to 2002, the average customer base increased by 5.1 percent, while gallons sold increased by 9.3 percent (see chart 6B).

Yet, for the near-term future, 31.4 percent wish to gain customers in their current territory, 22.5 percent plan to add storage capacity and the combined plan is to increase the vehicle fleet by 16.8 percent. Of the largest retailers, 51.6 percent plan to acquire – an enormous leap from the 9.7 percent who actually acquired so far in 2002.

The real astonishment is that roughly 25 percent of the retailers who sell less than 1 million gallons per year expect to be acquired in the next 12 months. Reading between the lines of some of the returned surveys, one could almost hear, “I’m either going to grow this business, or I’m getting out (see chart 6C).”

Optimizing the Business

After a review of the statistics displayed by this survey, the propane industry could be characterized as the picture of an industry full of businesses that take care of themselves as they have for at least 20 years (see chart 7A).

We calculated the correlations between predicted 2002 gallons sold and a number of other variables. The absolutely astounding result was that – with the exception of the largest retailers who skewed the overall average results – almost nothing correlates with anything else (see chart 7B)!

Even among the large players, only four variables demonstrated a correlation above 0.307 (out of 1.000). All four of the correlations were above 0.871 and related entirely to the size of the business as it exists. They are number of total vehicles, number of customers, number of bobtails and storage capacity. In essence, what this tells us is that the only predictable indicator of how many gallons of propane a retailer will sell this year is how many gallons he sold last year.

The assumption surrounding this view is that there is a relatively stable number of customers for propane, and demand is influenced primarily by the weather in the heating season. This leaves each retailer with several choices for growing the business: add ancillary products and services, grow market share, or acquire other retailers.

However, the relative similarity of percentage of products and services offered within gallons-sold groups could indicate market saturation. There is a defined and limited market for propane appliances, which is also significantly impacted by the state of the national and local economies.

To grow market share without acquisition, a retailer must offer a competitive advantage. Even when 78.8 percent of retailers believe their competitive advantage is quality of service, it is tough to pull existing customers away from competitors in a market that claims 52.7 percent of their bond with customers is loyalty (see chart 8).

Of course, there is always the pricing strategy: undercutting costs to gain customers, hoping to recoup the loss of customers who have changed suppliers. This is not usually a successful strategy, especially in markets where retailers operate under very similar product cost and market pricing structures. One of the most consistent results from the survey was the average gross margin per gallon (average of highest and lowest prices charged minus average of the highest and lowest prices paid). The result was a rock-solid $0.57, across all groups with less than a nickel difference.

If the above assumptions and conclusions are accurate – with such dependence on the weather and the economy – it means that there is little opportunity to increase the bottom line of these businesses from the revenue side of the equation without acquisition (which may be why 51.6 percent of the large retailers say they want to acquire).

Further Points to Consider

There are expense variables that we did not examine in this survey that relate primarily to source, method and strategies for propane procurement.

Some of the variables we did examine on the expense side are truly uncontrollable in the foreseeable future for most retailers. These include the character of their market areas as it relates to propane demand – factors such as the level of natural gas infrastructure, the geographical dispersion of customers, the total industrial and commercial usage in the area, etc. (see chart 9).

Conversely, there are a few variables that are controllable by the business. These primarily relate to the balance between the efficacy and efficiency of operations, and include propane storage, vehicle fleet and workforce.

The cost of propane storage includes the initial investment, maintenance and carrying costs associated with the sites and tanks. Of course, the decisions regarding adding sites and tanks is more complex than the information gathered by this survey. But several key indicators may shed some insight.

One of these indicators is the average number of gallons sold per customer. While this is certainly one of those market composition issues, the range from the survey is 901 gallons per customer from the smallest retailers to 1,932 for those in the 500,000 to 999,999 category.

Interestingly, the largest retailers sold the fewest gallons per customer at 810. Those retailers who sold over 4 million gallons reported that they had 7.15 times more customers than those who sold 2 to 4 million, and 11.1 times more than those who sold between 1 to 2 million. But when looking at gallons sold, they reported selling 4.96 and 9.1 times more gallons, respectively.

In other words, while they had 7.15 times more customers, they sold only 4.96 times more gallons than the next highest category. Compared to the next category down, they had 11.1 times more customers but sold only 9.1 times more gallons. While it is true that one can find both large and small retailers who have large and small customers, the results suggest that the big guys don’t sell as much propane to each customer as do the other retailers.

Perhaps the most pertinent indicator of storage efficiency is inventory turns: how many times were the tanks filled and emptied during the year? It goes without saying that this is also a vehicle quantity issue, but the numbers proved to be quite consistent.

The average was 20.6 annual inventory turns, with the most efficient at 26.2 and the least at 16.9. Admittedly, there could be a number of reasons for having few inventory turns – from just plain bad planning to facing an uncertain supply situation and making a safe storage decision.

As noted, these three variables are highly interrelated, but the gallons sold per vehicle proved quite predictable. As the size of storage, customers and sales increased, the gallons sold per vehicle grew at a very understandable rate from 96,988 to 247,130.

Finally, there is the issue of the workforce. Very intertwined with storage, customers and vehicles, one indicator that stands out is customers per employee. The average was 228 and seemed to provide a fair benchmark with understandable variance.